Debit and credit cards may function similarly, but only the activity from credit cards contributes to your credit report. By understanding how your debit and credit cards affect your finances and credit score, you can pinpoint when it is best for you to use a credit or debit card for specific purchases. This can be especially helpful if you actively use both debit and credit cards but want to improve your credit score while avoiding interest charges and extra fees.
Can you build credit with a debit card?
Unlike credit cards, debit card activity isn't reported to the three credit bureaus (Experian®, Equifax®, and TransUnion®) that monitor and provide access to your credit report. When you make a purchase with a debit card, the funds are deducted from your checking account. Debit card purchases are made with your own money while credit card purchases are made with funds used against a credit line approved by a credit card issuer. If you choose to close your account or change banks, your credit score won't be affected as debit cards don't contribute to your credit utilization ratio. This is the ratio between the total balance you owe and your overall credit limit to see how much credit you're using. Keeping balances below 30% of your credit limit could help your score.
When to use a debit or a credit card
When making a large purchase that may come close to exceeding the amount of money in your checking account, you may be better off using a credit card. If you were to make a purchase, ATM withdrawal or have an automatic payment go through that exceeds the amount of money you currently have in your checking account, you may overdraw your account. However, overdrafts and insufficient funds for your checking account aren't reported to the three credit bureaus.
In some cases, it may be more worthwhile to use your credit card for purchases that could result in overdrawing your checking account. For example, if you make a purchase of $1,500 for a laptop at a store and only have $1,450 in your checking account (and you're charged a $32 fee if you overdraw your account) your total amount spent would have been $1,532 when your bank's fees and overdraft policies begin to apply or your transaction may be declined. If this same purchase had been made with a credit card, you wouldn't be charged an overdraft fee as long as you remain under your credit limit. If you paid off the balance before the start of your next billing cycle, you can also avoid paying interest and instill good habits toward your credit score by making an on-time payment.
When to use a debit card
It may be best to use a debit card if you want to:
- Avoid interest charges: You won't have to worry about the interest rates that credit cards charge when a balance isn't paid in full by the end of the billing cycle.
- Prevent debt: Debit cards may be the best option to use for those who are currently in debt and don't want to borrow more money.
- Avoid over-spending: Those with the tendency to overspend will find sticking to a budget with a debit card more manageable since you're spending your own money and not borrowing against a credit limit.
When to use a credit card
It may be best to use a credit card if you want to:
- Improve your credit score: Using your credit card a few times a month on purchases that you can pay off in full each month could increase your credit score over time.
- Earn reward points: If you have a credit card that earns rewards points or cash back on certain purchases, your purchases may result in accumulation of rewards points, miles or cash back.
- Avoid overdraft fees: As long as you stay within your credit limit, you won't have to worry about overdraft fees.
Using a credit card to improve credit score
Credit cards can help improve your credit score over time, especially if you make frequent purchases and pay off your balance in full each month. Credit cards have a specified credit limit that may provide more flexibility when it comes to making purchases or if emergency expenses come up. Debit cards could help you stay within your budget since your purchases are deducted from your checking account. Although only credit cards directly affect your credit score, both debit and credit cards can play a role in your personal finances.