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Raquel Garcia is serious about avoiding debt. The 18-year-old customer-service representative for U-Haul recently canceled her credit card. Now she gets her entire paycheck deposited onto a prepaid debit card, which she uses for all her purchases.
Because she can access only what's in the account, Garcia no longer worries about breaking her budget. "I'm spending just what I need," she says.
For consumers reeling from a series of economic body blows, debit cards are increasingly becoming the plastic of choice.
Some use the cards, which pull money directly from a bank or other account, as a budgeting tool to limit spending. Others embrace them out of necessity as banks clamp down on credit.
All told, debit purchases are expected to climb 13% in 2008, to $1.2 trillion, according to The Nilson Report, an industry newsletter -- compared with a 3% rise, to $1.9 trillion, for credit card transactions. At Visa, the No. 1 card company, debit spending could surpass credit this year.
For the banks issuing the debit cards, the trend seems bittersweet. On the plus side, debit cards don't pose a threat to the banks' books like credit card accounts do (credit card losses are mounting as borrowers fall behind on payments). But the profits on debit cards aren't as plump because banks don't collect interest on them.
Issuers largely make money from debit card fees, which pale next to those on credit cards. Retailers, for instance, fork over 1.6% of credit purchases to banks, three times the amount on debit transactions.
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But don't shed a tear for the banks just yet. Time and again they've shown an uncanny ability to adapt to a new profit landscape, and the debit card business appears no different.
Consider the evolution of overdraft fees. It used to be that banks denied debit purchases when consumers didn't have enough money in their accounts. Now 14 of the 15 largest banks approve transactions but hit customers with a fee if they exceed the funds. It's not unlike getting charged for bouncing a check. A recent study by Bankrate.com found that overdraft fees now approach $29, up 3% in the past year.
Those penalties are easier to trigger, too. In the past customers had up to a couple of days -- the time it takes for some debit transactions to clear -- to deposit cash. But now many banks hit them with fees as soon as purchases are made.
"Banks have turned to this as a major source of revenue," says Jean Ann Fox, the director of financial services for advocacy group Consumer Federation of America.
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The practices have become so prevalent that the Federal Reserve has proposed rules that would rein in perceived abuses (see "When banks turn evil"). The banks argue that they provide a necessary service to consumers.
"There's a balancing act to ensure folks who do need to occasionally go over the limit have (the protection) while having a deterrent in place for people who abuse it," says Doug Johnson, a policy adviser for the American Bankers Association, an industry group.
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