For those trying to build up a good credit history, or even repair and rehabilitate a less-than-ideal credit history, knowing how to use debit and credit cards effectively can be a powerful tool for those trying to build up a good credit history or even repair and rehabilitate a less-than-ideal credit history. While one can help you build credit, one can help prevent high-interest debt.
For a debit card purchase, the money is taken from the account when the authorization is issued. For a credit card purchase, the authorization is issued under the terms of the issuer, up to the limit. The charges are billed monthly, so the funds are not needed at the time of purchase.
While this may seem simple on the surface, there are many times when you might want to use one over the other. This is particularly important for people working on their credit since credit scores and reports weigh credit cards and debit cards very differently. In most cases, you won't even see one of them on your credit report. Let's take a closer look at exactly how deep the differences are between debit and credit cards.
Is There Any Difference Between Debit And Credit Cards?
There are some significant differences between debit and credit cards. The differences start at how you even apply to open each account, and they only diverge further from there. Let's take a look.
Your standard debit card is a card that is usually linked directly to an existing checking account. If you do not have an existing checking account, you will need to apply for one, which will usually entail answering some relatively personal financial questions to minimize the risk of fraud.
With the diversity in financial products being offered now, there is also the possibility that you may be able to get a debit card issued on any number of different accounts, from brokerage cash accounts to investment accounts, and even crypto platforms offer debit cards.
Despite the wide variance in the account sources that the debit cards can draw from, they will all operate in a relatively similar way. When you make a purchase with a debit card either at a point of sale or in a digital sales portal online or in an app, for example, the purchase can usually only be made for the total available funds in the account.
When the authorization is granted, the funds are immediately taken from the account and are finalized or reconciled within a few business days.
Getting Into Debt With Debit Cards
In some cases, debit card purchases will be allowed to overdraft the drawer's account, subject to the terms of their account. It's vital to be able to keep your account open and in good standing that you be familiar with your bank's policies on overdrafts.
These terms will vary significantly from one financial institution to another, with some allowing constant overdrafts and bounced checks, some limiting overdrafts to a small sum, and some that do not allow any purchases without the funds available at the time of the request.
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Credit cards are far different from debit cards and are issued much differently as well. While it can be relatively easy to open a new bank account by heading down to the local branch, a credit card is much more challenging for some. When you apply for a credit card, not only will your credit history and overall creditworthiness be examined, but your income and ability to pay your bill will be looked at.
If you are approved, you will be given a line of credit with a specified limit, and a detailed explanation of the interest charges and how you will be billed. In most cases, the application and account opening is free, though a deposit is needed for secured credit card accounts.
When you make a purchase on a credit card, instead of taking your money immediately like a debit, you are billed monthly up to the specified account credit limit. If you are over the limit, your transaction will not be approved.
Credit cards can be dangerous if not utilized properly, since they charge interest, and your credit limit may be many times your monthly income. Most credit cards have some perks or bonuses that go along with being an account holder, particularly with rewards cards, but this also comes with the potential to accumulate significant high-interest debt.
It's not uncommon for people with poor money management to overspend on credit. This temporary oversight in spending control can suddenly result in paying not only the principal of the original debt but the interest that is continually accumulated. For some, this process takes months, for others, it can take years.
Do Debit Cards Help Build Credit?
This is an extremely common question, and while the answer may disappoint you at first, we've got more you should know.
The Short Answer
In short, no, regular debit cards linked to conventional checking accounts cannot help you build credit. In fact, if used irresponsibly, debit cards can actually hurt your credit significantly.
The Down Side To Having A Debit Card
Debit cards will almost always be linked to a personal or business checking account, which sounds reasonable on its face. But when you realize that many banks will allow their customers to overdraft their accounts, it can put you in a dangerous situation quickly. Once it happens, if you don't fix it, it can eventually damage your credit and lower your credit score.
With some banks, you may have to opt in for overdrafts, or they may require you to opt-out. Some banks will not allow overdrafts at all, so it's important to know your bank's particular policies on writing checks or making purchases without all of the money already present in the account.
In some cases, banks will even institute such severe overdraft policies that people will be overdrafted more than they can recover from. If the account isn't settled within a certain time frame the bank will generally close it, resulting in the account being sent for collections. Once this happens, not only has the original account been closed, but now you have a negative item on your report and debt to clear up.
Debit-Style Options That Help Build Credit
With the proliferation of small banks and the "appification" of much of America's financial interfaces, people are increasingly service-oriented when it comes to their financial products. This means that a lot of big banks are creating branches that answer the common question of "what can this bank do for me"? One of those revolutions has been the ability of banks to offer a more effective type of secured credit card.
Banks like Chime, for example, offer an account called Credit Builder that functions as a debit card but is then reported to the major credit bureaus monthly. This builds not only a payment history for the user of the card, but it also begins to contribute to measurements of their credit utilization score, which is another important metric in how your credit score is determined.
They are often incredibly simple to use, and they generally come with zero risk of over-drafting or generating traditional credit card debt. You'll move money from your checking account to the credit account in the app, essentially pre-funding the credit card.
For example, you move over $100 before going out to a restaurant and use the $100 on that card to pay for dinner. Assuming no other charges that month, that $100 is then reported to the credit bureaus as a $100 account balance that was paid on time. Repeating this month after month will contribute to healthy and robust payment history and a useful credit utilization rate.
Additional reading: How Often Does Your Credit Score Update?
How Are These Debit Cards Different Than Secured Credit Cards
With traditional secured credit cards, you would pay the security deposit upon opening the account. For example, many basic secured cards require $200 to open, at which point you are then able to use the credit card up to your $200 limit. The downside, however, is that your initial deposit is only used to pay your account if you default on your payments. If you charge $50 dollars your first month, you will still get a bill for $50 at the end of the billing cycle that you'll need to pay.
This makes getting traditional secured cards a more expensive option than finding a bank that offers a credit-building debit card option, particularly if you are trying to rebuild credit and may not yet be able to get approval for any credit but have checking accounts in good standing. On the other hand, if used wisely, having one or two revolving credit accounts that are paid and in good standing can help credit tremendously as well, but that's a topic for another time.
As you can see, there are many important differences between debit and credit cards. Depending on the features you need and your credit objectives, you should be able to use both your credit and debit cards effectively to reach those objectives.
Shawn Manaher is a former financial advisor, has founded 5 online businesses, and is a coach, speaker, podcast host, and author. He's been featured on The Consults Corner on TAE Radio, The Writing Biz, What's Your Story, and more.