Different Payment Methods
What are the advantages and disadvantages to the various ways we can pay for things?
What’s the best way of paying for things? Cash? Debit Cards? Checks? Prepaid cards? Money orders? Wire transfers? Credit Cards?
There are various payment methods, and each has its own advantages and drawbacks. Some tend to have more financial disadvantages than others.
I’ve heard from a lot of very dedicated people that they have the best system for managing their money. Some devotees of one popular financial guru will say that cash is the only way to go. Others swear by prepaid cards and gift cards. Still others stay loyal to money orders and wire transfers because it’s all they know or they’ve been blocked out of mainstream banking options.
Is there one answer that works for everyone in every situation? Of course not, no more so than if we said there was one shampoo that works best for everyone. Different methods of payment are appropriate in different situations. Let’s go through them one by one. By the end of this chapter, you should be in a better position to determine which method works best for your lifestyle and financial needs.
Cash is king. It’s true. Without cash (whether in our wallets, bank accounts, or tied up in CD’s and money markets), there is no true financial security. To some, cash might seem “old school,” but for others, a cash-only system seems to hold the key that will magically transport them back to a time when debt didn’t exist and credit didn’t lead people into financial holes they couldn’t dig themselves out of. Like any rose-tinted glasses peering into history, such optimism is a bit too, well, optimistic. Don’t get me wrong. I truly believe that there is a definite place for cash in daily, weekly, and monthly money management systems. Studies are pretty clear that, contrary to the old notion of cash burning a hole in your pocket, using cash actually means that most of us spend less each month than if we’re using plastic (whether credit cards or debit cards). How much less? Keep reading to find out.
Who is the cash-only system for, and what are its advantages and disadvantages? The cash system is likely the best option for anyone or any household constantly in credit card debt or living paycheck to paycheck, finally ready to make a financial change for the better. Not only do we spend less using cash, we actually can’t overspend. If we go into a store with only cash in our wallets (no plastic and no checks), we cannot overspend, unless we open up a store card account on the spot, which we hereby solemnly swear not to do in such cases. How to Build Credit
The challenges of a cash-only system are numerous and not trivial. First of all, there’s the biggest challenge of all. How do we go from living paycheck to paycheck, making only minimum payments on credit cards, and using credit cards to purchase day-to-day items, without bouncing checks and miss payments? From Credit Card Debt to Cash Only
The second challenge actually is a bit trivial. It’s inconvenient. We need to go to the bank or credit union regularly and withdraw the right amounts of cash in the right denominations to take care of all our bills. The strictest of cash-only crazies would also pay their bills in cash at the place of business rather than sending it by mail.
The third challenge is not as trivial as some make it appear to be. Using cash means never using credit cards. I can be just fine with that, until someone asks me (and many have) how they can build their credit without using credit. This question usually comes in the context of someone wanting to qualify for a home loan. The reality is that if we want to build credit, we actually have to use it. For the foreseeable future, there’s no way around that. I’ll go into this in detail in the chapter on credit. Besides, there’s more to credit than just purchasing a home. Our credit reputation can often influence our employment applications, our apartment rental applications, our vehicle and homeowner’s insurance premiums, our ability to get student loans for our children, any elective surgeries we want that are not covered by insurance, and more. So, if we choose to go cash-only, which I’m certainly not against since I often use the method in my own home, just be aware that there are tangible downsides to it. Often, the advantages outweigh the disadvantages.
This payment option has its advantages but also some definite downsides. Most people would think that debit cards are the best option for households trying to live within a budget. After all, we can’t overspend with a debit card be-cause it can only draw against the funds that are already in our checking account, right? Yes and no. Yes, debit cards draw the payment directly (and pretty much immediately) from our checking account. Theoretically, when we’ve spent all of the money in our checking account, our debit card should stop working. However, many people have opted in to overdraft systems that approve the purchase and then either charge the customer a hefty overdraft fee (commonly twenty to thirty dollars) or their financial institution takes the overdrawn amount directly from the customer’s savings accounts with the same institution.
Even if we haven’t opted into these overdraft programs, we need to be aware of the findings of a study on human nature when it comes to purchasing with plastic. It doesn’t matter if we’re talking about debit cards, credit cards, gift cards, or store cards, if it’s plastic, we tend to spend upwards of 50 percent more than we would using cash or a check. The difference can be dramatic and can dramatically impact a business’ bottom line. In 1980, L. L. Bean began accepting credit cards and observed that customers using credit cards had average purchases 30 percent more than others. Not coincidentally, Visa found in a study over six years ago that people using credit cards (which studies show we equate psychologically with debit cards when it comes to purchase amounts) spent 30 percent more than those who used cash. So, if we’re using a debit card for all of our purchases because we think it helps us to “control” our spending, might I suggest we consider switching to the cash-only method? We could save 10–50 percent immediately on our discretionary spending. For the average household, that could easily be $400 or so!
Another downside to debit cards starts with the security benefits built into the cards. Yes, if we lose our debit card and report it stolen within two business days of learning of its loss or theft, we’ll likely get all of our money back, minus up to about fifty dollars (thanks to the Electronic Fund Transfer Act signed by President Carter all the way back in 1978), even if someone used it fraudulently to drain our accounts. However, unlike credit cards, where the thief was actually spending the credit card company’s money and not our money, losing a debit card might mean that we’re out of money and out of luck for however long it takes our bank or credit union to resolve the fraud case (possibly several weeks). This is why most financial experts would recommend that we carry and use credit cards in situations when we can least afford to be without money, such as when traveling away from home. Still, we use debit cards regularly in our household, particularly for groceries and around town expenses.
It won’t be too far in the future when a teenager or a young adult will ask us what the expression, “The check’s in the mail” means. After all, many being born right now will likely never write a check. If they receive a check for payment, they’ll take it to their financial institution, but not to deposit it. They’ll go and ask them what it is and if it has any historical value.
Okay, so I’m not too optimistic about the long-term survival of our dear friend, the paper check. But what about now? Does it still make sense to use checks? Of course. A study by Dilip Soman found that using either cash or a paper check, because the purchase requires us to count out or write down the amount we’re spending, actually leads us to spend less than if we were to use plastic.5 However, in our world of instant everything, where an extra twenty-five seconds at the checkout stand is an eternity, checks are not so convenient. Plus, mailing checks will require the additional purchase of a post-age stamp (another future relic from our present).
Are there any other benefits of using checks besides spending a little less? Some might think they’re easier to track than electronic purchases, but that’s not necessarily true. Bank statements automatically show either the name or the address of the business where we used our debit card.
Still others think checks are safer than debit cards or online payments. Again, not true. Electronic payments online are much safer than placing a check in the mail. Checks can be stolen (from our mailbox or from the recipient’s mailbox), acid washed, and rewritten payable to the thief in any amount they choose. Yes, our financial institution has some safeguards against such fraud, but that doesn’t make such experiences pain-free.
Still not a believer? Let’s look at the bottom of a check. What do all those numbers mean? They include our financial institution’s routing number and our account number. It doesn’t take a deep thinker to figure out what kind of financial damage could befall us if those two numbers fell into the wrong hands.
Additionally, checks are no longer even accepted by many businesses. Many restaurants and gas stations have a sign stating that checks are about as welcome as the plague.
Finally, most banks or credit unions do not give us free boxes of checks. We’re required to buy them. However, if we’re only using a couple of checks each month, it is worth asking our financial institution to provide us with some temporary checks. Many will give us three to ten such checks each month at no cost.
With the advent and maturation of free bill pay services from our financial institutions, why would we ever write another check anyway? We can use our free bill pay to send money to our brother-in-law for the sushi party we had (I did). We can use it to pay for our child’s lunch at school (rather than using their online service that probably charges us a service fee). We can even use our free bill pay to make donations to our church or to our favorite charity. If the organization accepts checks, they’ll accept bill pay. Even if they don’t accept checks, we might be able to set up a direct transfer from our account to the organization’s account. They just need to provide us with their account number, which they should since it’s already printed on any check they issue themselves.
Prepaid cards, including the prominent Green Dot Visa and the Bluebird American Express cards, have been growing wildly popular. Former and even some current bank and credit union customers who have incurred hefty over-draft or bounced check fees, in addition to those enduring mounting monthly account maintenance costs, have been turning to prepaid cards in droves. Not all prepaid cards, though, are created equal. Green Dot currently charges its customers a hefty $5.95 a month while Bluebird advertises no fees other than some for uncommon situations. There are several others out there. All cards have some fees, but some cards are all about the fees. Beware of cards with high-profile endorsements, because they can come with monthly fees of fifteen dollars just to carry the card. Ouch!
However, one of the benefits to using a prepaid card is that we can’t overspend with them. Check that. I should say “most” of them. Some will actually charge a fee if we try to make a purchase for an amount greater than what is on the charge card. Obviously, we should avoid such cards.
Generally, though, I can see a place for cards like these in household finances, particularly for variable expenses like groceries, entertainment, dining out, or chocolate. What? Don’t all households have a chocolate category in their budget? After loading the budgeted amount for the month onto the prepaid card, we can use it till it’s gone, but then it’s gone. We leave the other methods of payment home, and we can’t overspend.
While not technically the same thing as a prepaid card, gifts cards can be used in a similar fashion. Just be sure to understand all of the fees (purchase, loading, reloading, etc.) the gift card might carry, steer clear of those that would be more expensive than the pre-paid cards referred to above.
When I start talking about money orders, it means we’re getting into some of the more expensive options when paying for goods and services. To those who use money orders, a $.50 or a $1.50 fee may not seem like much, the same way spending four dollars each day for energy drinks might not seem like much to caffeine junkies. Over time, these fees build up. If we use just eight money orders per month to pay for utilities, rent, cell phone, a couple of debts, and a mail order transaction, we could easily spend $75 to over $120 each year just in fees.
Additionally, money orders are typically limited in size to $1,000 or less. However, they do make for a decent payment option if we want to ensure the payment is not slowed by check processing or to avoid carrying a lot of cash to make a major purchase (such as buying a used car or buying something off of Craigslist or eBay).
Contactless Purchase Methods
Contactless purchasing is still technically either using your credit or debit card to make a payment, but it aims to make the process easier. It certainly comes with some risk, such as creating access to money you don’t need to spend and perhaps there may be future security concerns.
Essentially a payment method becomes “contactless” when the actual credit or debit cards isn’t used because they or stored electronically in a digital wallet that doesn’t require a physical copy of the card when a purchase is made. Rather it relies on radio-frequency identification (RFIC) or what is known as near field communication (NFC), such as Google pay, Fitbit Pay or any bank mobile application that supports contactless for making secure payments)
Wire transfers are expensive, easily costing twenty-five to fifty dollars to send (let alone the fee to “receive” the transfer) each time. If you find yourself needing to wire money perhaps a better alternative would be a prepaid card?. An individual in country ABC can open a prepaid card such as this and send a second card to the family member, friend, or associate in country XYZ. The individual in country XYZ can then use the card anywhere MasterCard is accepted.
Credit cards are a double-edged sword when it comes to using them for making purchases. On the one hand, they are very secure and safe to use. There are protections for the purchaser against fraudulence and, in some cases, even poor consumer service (geographic limitations apply). Additionally, most credit cards do not charge any interest if the balance is paid in full by the due date.
On the down side, there is, of course, interest. Since I began teaching money management back in 2004, the average credit card interest rate on standard cards has generally varied between 13.5–16 per-cent. Additionally, as mentioned earlier, if it’s made of plastic, we’re likely to spend 10–50 percent more on everyday purchases with a credit card (or debit card) than with cash or a check. Furthermore, I’m not a fan of credit cards that charge annual fees, even if they are travel reward cards. Most households are better off saving that annual fee and saving the additional charges they’re likely to incur through just having and using a credit card.
Electronic Funds Transfer (EFT)
For our purposes, the final method of payment to discuss goes by several common and not-so-common names: online payment, EFT, Automated Clearing House (ACH), direct transfer, account-to-account transfer, inter-institutional transfer, and more. Basically, an EFT is how I refer to payments made over the Internet that go from the bank or credit union directly to a merchant. While this sounds like the same thing as a bill pay, an EFT transaction is initiated by the merchant, not by us or our financial institution. Usually, we set up the payment at the merchant’s website by providing them with our checking account number and our financial institution’s nine-digit routing number.
I’m actually a big fan of EFTs. They may seem very similar to online bill pay, but when it comes to online bill pay, we can’t actually control when a payment will arrive at its final destination. If I use my credit union’s bill pay system to cover a credit card payment or a utility bill, and if that payment arrives a day or two late, guess who’s responsible for paying any related late fee? I am.
If, on the other hand, I set up an EFT with that credit card or utility company, they now are responsible for drawing my payment from my bank or credit union. If they draw it a day late, it’s their own system’s fault and not mine, so I’m not responsible for a late payment.
The main challenge with EFTs is to set them up and then remember them. Make sure to note the date any EFT is scheduled to process so that you have sufficient funds in your checking account to cover the charge. Also, if you ever close either the merchant account or your checking account, make sure to cancel the EFT with the merchant.
I have most of our bills set up to pay each month through EFTs: mortgage, utilities, credit card (full balance), insurance, and so forth. Plus, they’re generally free!
Now that we’ve discussed the most common methods for making payments, we are better prepared to decide upon the method that fits our own various situations best.
A student in one of my classes reacted with dismay when I suggested that we pay our set bills (such as utilities, mortgage, cell phone, internet provider, etc.) online. I described how setting up accounts with these companies allows them to deduct our monthly payments directly from our checking accounts. My student was impatient to point out that he had set up online payments and that he had subsequently had to pay a number of late fees because his payments didn’t always arrive on time.
To me, the fact that he said the word, “arrive”, meant that he and I were not talking about the same payment method. I am generally a fan of having payments “taken” our of our checking accounts by the company we owe money to. Such a payment method is known as an ACH payment (Automated Clearing House”). On the other hand, my student was talking about online bill pay through his bank or credit union.
Once we were on the same page, I agreed with him. Using bill pay can be a great option so long as we schedule the payments far enough in advance to ensure they arrive before their due date.
The main note of caution regarding ACH payments is to make sure we don’t let our account balance get so low that an unexpected, or more likely, an unrecorded ACH will overdraft our account.
What to Do & Not to do when deciding which payment to use
Don’t use payment methods that charge unacceptable fees (basically, any fee seems unacceptable to me).
Don’t carry excessive amounts of cash in your wallet or purse.
Don’t ever write your PIN on your debit or ATM card!
Do understand that the method of payment matters in real dollars in our wallets.
Do plan ahead for payments. The more “rushed” the payment, the more we typically pay in fees.
Do accept that there is almost always a better and more affordable way to pay for things in our household budget. Stay alert!