Debunking Credit Card Myths: Is a Debit Card Better for Your Credit History?
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It's no surprise that travel rewards credit cards are a popular discussion here at TPG. By strategically opening and utilizing them, you can earn large sign-up bonuses and extra points in a variety of categories of everyday spending, opening up fantastic redemptions like premium-class flights and luxurious hotel rooms. However, there are a number of misconceptions out there when it comes to credit cards, so today I’ll continue our new series that debunks these myths and allows you to begin planning for your next vacation.
Previous entries includes having too many cards, closing a card you don’t use, how permanent of an impact an application has on your score, not paying your balance in full, paying an annual fee, keeping your points when canceling a card, whether annual fees count toward a sign-up bonus, what to do if your application isn’t immediately approved, whether cards are a surefire way to get into debt, whether you should accept a credit line increase and whether carrying a balance helps your score. Today I’ll continue looking at your credit score and debunk a common myth when it comes to debit vs. credit cards.
Myth #12: A debit card is better for building up your credit history than a credit card.
Many people prefer to utilize a debit card as opposed to a credit card for the majority of their transactions. While this may be rooted in fear of the unknown, it also may be simple recognition of the dangers of a credit card. When you open a new card and get a credit limit of $20,000, that's not just free money. You may not trust yourself with a large line of credit and instead rely on the immediacy of a debit card. After all, there's no "buy now, pay later" aspect of a debit card. That money comes out of your bank account (almost) immediately.
Unfortunately, there's an important misconception when it comes to debit cards: These products do not have any impact on your credit score. This should be clear simply through semantics; why would a debit card impact your credit score? Nevertheless, I've read many comments on message boards and other sites asking this exact question, so it's clearly still on people's minds.
At its most basic level, your credit score is a numerical representation of how well you manage lines of credit that have been extended to you. As we've covered before, it's made up of five factors:
- Payment history
- Amounts owed
- Length of credit history
- New credit
- Types of credit used
Remember too that these are not equals, as some are weighted more heavily than others:
As you can see, none of these apply to a debit card. There's no "payment history" on those accounts, since every transaction comes out of your bank account individually. You'll never owe any amount on a debit card, and since there isn't any type of credit line extended to you, the last three factors don't come into play either.
Unfortunately, over-relying on a debit card can come back to haunt you when you're looking to finance a new car or buy your first house or even apply to rent an apartment (where the landlord or leasing company runs your credit). If your credit history is minimal or even non-existent, you may run into difficulties securing these types of loans. Even if you do secure them, you may be charged higher interest rates due to the fact that the lender isn't sure of your creditworthiness.
All of this can be avoided by opening and utilizing a credit card. I'd recommend starting with a no annual fee card like the Chase Freedom Unlimited or Citi Double Cash Card so you won't have to "invest" anything right off the bat. These also offer simple rewards for every purchase your make. You'll want to carefully set boundaries for your spending so as not to rack up a huge bill, and be sure to pay off the balance in full every month. Even just a handful of transactions each statement period will demonstrate to the credit bureaus that you are responsibly managing your available credit, improving your credit score and making you more attractive to issuers down the road.
For additional recommendations for managing your credit card account(s), be sure to check out my Ten Commandments for Travel Rewards Credit Cards.
Debit cards often seem like a safer payment method than credit cards, since you aren't at risk of overextending yourself. The money comes out of your account right away, preventing a large bill at the end of the month that will accrue interest charges at a very high rate. However, using a debit card won't have any impact on your credit score, making it more challenging to obtain loans in the future. While you should always stay within the limits of what you can afford to actually purchase and pay for each month, a credit card should play at least some role in your financial strategy. Hopefully this post has shown you why that's the case!
What are your thoughts on debit vs. credit cards?