Debit cards are convenient and they certainly have the look of a credit card, but they do not function in the same way or have the same protections as a credit card. Let’s look a little closer at debit cards and find out what they can – and cannot – do for you.
Most consumers with a checking account have access to a debit card.
There is no argument that debit cards are convenient and they certainly have the look of a credit card, but they do not function in the same way or have the same protections as a credit card. Let’s look a little closer at debit cards and find out what they can – and cannot – do for you.
Do debit cards build credit?Debit cards are designed like credit cards, and many even bear a Visa or Mastercard logo. But using them will not help you build your credit. Why? Because you are using your own money, not credit, when you use your debit card to make a purchase. You are not borrowing money, which is what you are doing when you use a credit card.
This is not to say that debit cards don’t serve a purpose. Since a debit card depends on the money you have in your checking account, it works like an old-fashioned paper check, but easier and faster. Unlike a check, you normally don’t have to show identification when you use your debit card. They are also more widely accepted than checks are in most cases. And they are safer than carrying around wads of cash when you are out running errands or traveling.
So even though they don’t build credit, debit cards are great, right? Not so fast! Debit cards do not have the same consumer protections that credit cards have. In brief, if your debit card is stolen the thief may have access to the cash in your checking or savings account. You have two business days to report a stolen debit card to the bank in order to keep your liability to $50. Take longer and it could cost you $500. If you don’t notice or report the theft for 60 days, your entire savings could be lost. A credit card has a maximum liability of $50 under the Fair Credit Billing Act for fraudulent charges.
It is also important to remember that when you use your debit card, the funds can be immediately removed from your bank account. And while you may have overdraft protection with your bank, you still may run the risk of having the card denied if you don’t have the funds available for your purchase. This can be both frustrating and embarrassing.
See related: Do bank overdrafts affect your credit score?
How credit cards help you build credit
As noted above, when you use your debit card you are using your own funds, and that is why they have no effect on your credit. But a credit card is a way to use someone else’s money (the credit card issuer). They will cover the cost of whatever it is you are buying and then bill you for the purchase. Your agreement with your credit card company comes with the expectation that you will make at least minimum payments toward those purchases on a regular (usually monthly) basis.
Payments are reported to the credit bureaus. Making payments on time and as agreed will help build your credit because payment history is very important in credit scoring. It comes in at No. 1 for FICO and is “moderately influential” to your VantageScore.
Another way credit cards help is by building up the available credit listed on your credit reports. If you get a credit card with a $500 limit, that means you have $500 of available credit. If you buy something that costs $100, you have used 20% of your available credit.
This will be important to your score, because credit utilization is second only to payment history for your FICO score and is “extremely influential” to your VantageScore. I recommend that you never use more than 25% of your available credit if you can help it. Those people who have the best credit scores keep their utilization in the single digits, so keep that in mind.
Some people shy away from credit cards because they don’t want to get into debt. This is understandable; many of us know someone who got in over their heads with credit cards and had a hard time getting out from under the debt they accrued. Credit newbies are often the worst offenders, but certainly they are not the only ones.
Getting a credit card requires you to understand what it is you are signing up for; putting a purchase on a credit card doesn’t mean it’s paid for. A credit limit is not additional income. It just allows you to spend money you may not have earned yet, unlike a debit card. (If you are living paycheck to paycheck, I recommend using a debit card rather than a credit card for this reason.)
And if this is your first card, chances are you will have an interest rate in the double digits. If you don’t pay your balance in full, you will be charged interest on your purchases and that could increase the cost of whatever you bought to more than you had planned or budgeted for.
Never using credit cards can hurt your score
People who have shied away from credit cards for these (or other) reasons may run the risk of having a low score, or even having no score at all. It is true that you don’t have to have a credit card to have credit; a car payment or other installment loan that is reported to the credit bureaus will give you a credit score. But without credit cards, or some other type of revolving debt like a credit line, your credit mix will suffer.
And while credit mix only counts for 10% of your FICO score, its effect will be more pronounced if you have little data in your credit report, or a “thin” credit file. And if you don’t have a car payment or any other credit, you run the risk of being “credit invisible,” without a credit file or score at all.
See related: What credit score do you start with?
How to build up your credit if you’ve been using debit only
If you have resisted credit cards and been using debit only, there are ways to build your credit without taking on debt. With a little discipline, you can have credit cards, build a credit score and still keep to your plan. One way to do that is to start with a credit card that is easy to qualify for. Retail or gas cards are often the first choice for those new to credit for that reason. You could also look at secured cards (which require a deposit from you) or starter cards.
There are cards available for almost anyone with verifiable income. Buying things only when you have the money in the bank to pay for them in full shows that you know how to live within your means.
Once you have your card, you can treat it like your debit card if you like. Just because the bill may not come due for a few weeks does not mean that you can’t go ahead and pay if off immediately, especially if you can do it online. You don’t have to do that, of course, but be very sure to make your payment by the due date. And keep an eye on your utilization; the last thing you want to do is max out your first credit card.
Just like everything in life, your creditor needs to get to know you before trusting your judgment. Take it slow and don’t rush to add new credit to your file. This is true even though we talked earlier about how credit mix can affect your score. You can look into adding more credit after you’ve had your card for a few months and have successfully navigated those early waters.
Remember to keep track of your score!