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Debit Card Downfalls

Trading credit for debit is an effective way to manage tight finances during the recession. However, there are some risks involved when using debit cards that can cost consumers money.

"Early Show" financial contributor Vera Gibbons explained there are some surprising pitfalls to using debit cards that you might not expect.

But why are so many Americans making the switch from credit cards to debit cards in the first place?

Many Americans, Gibbons explained don't want to wait for the bulk of credit card reform measures to go into place in 2010. Also banks, looking to boost profits, are reducing the risk of debit cards by offering new perks for consumers willing to switch, such as rewards programs.

And it's working, Gibbons said. Debit cards, she said, now account for about half of card transactions.

However, debit cards do have their pitfalls, such as overdraft fees.

Banks are going to collect nearly $40 billion in overdraft fees this year, Gibbons said, and a lot of those overdraft fees come from debit card purchases.

"If you are the type who uses debit card for every single purchase, you have likely been hit," she said.

Debit cards are often touted as a great way to manage your finances because they don't have interest charges and other fees - and can be an effective way - but if you go over your limit, Gibbons said, you are in essence paying sky-high interest.

Gibbons cited an example from a Federal Deposit Insurance Corporation (FDIC) study, which found a $27 overdraft fee that a customer repays in two weeks on a $20 debit purchase would incur an annual percentage rate of 3,520 percent. By contrast, penalty interest rates on credit cards generally run about 30 percent.

And while debit cards are offering some rewards now, they are far fewer, and less valuable then rewards credit cards offer. With $100 in cash back rewards on credit card, you have to spend $10,000. To get same amount of cash back with debit cards, have to spend twice that, $20,000.

In addition, with credit cards the customer has leverage if something goes wrong, such as billing errors or charges for items never received - there are ways to work with the credit card companies to get that charge waived.

However, with a debit card, liability varies depending on when you report the loss: within two days the loss is capped at $50; report within 60 days, $500; beyond 60 days, there's no limit. The loss is all on the consumer.

Reloadable prepaid debit cards are also an option for consumers.

These cards are for the 80 million people who have little or no access to bank accounts, Gibbons said, and the industry is growing.

Last year, she said users loaded about $9 billion of these cards - but a lot of the money, she noted, went to banks. That's because fees quickly accumulate, including activation fees, ATM withdrawal fees, balance inquiries, and purchasing fees.

Also there is little to no maintenance and customer service, and there's also an inactivity fee if you don't use it for 60 days. The average cost per month, Gibbons pointed out, is $39 to $79.