As you build and protect your credit, it’s important to keep an eye on everything that affects credit scores. For the most part, that means making loan payments on time and using credit wisely. But it can get confusing when you consider all the plastic in your wallet. Debit cards, for example, are processed much like credit cards, but they do not impact credit scores, nor can using them help you to build credit.
Debit Cards and FICO Scores
The FICO score is the most important credit score for major loans like mortgages, auto loans, and most credit cards, but it is based on how you handle credit—and debit cards are typically just an extension of a checking account. Payments are drawn from a checking account, just as if you were writing a paper check. As far as FICO is concerned, the factors considered in your credit score include:
- Paying your bills on time
- Borrowing in moderation
- Having a history of borrowing (the longer the better)
- Using a variety of loan types
- Not racking up debts quickly
Credit Transactions on Debit Cards
Debit cards use money from your bank account, so no loan is involved except for small, short-term loans that might be part of an overdraft line of credit. Credit cards, on the other hand, are most certainly loans, so they affect your credit and can help you build credit.
Even if you select “credit” when using your debit card at a retailer, this does not cause your debit card to work like a credit card. The money still comes from your bank account, but the transaction is processed through credit card networks.
Alternative Credit Scores
While the FICO score might be the most important credit score, other scores are increasingly used for lending decisions—especially for people in the process of building credit. It’s not likely that you’ll get a home loan with one of those scores, but they can help you qualify for smaller loans—which are stepping stones on the way to solid credit history. These alternative credit reporting companies also are used for such things as employee screening, insurance rates, and more.
With alternative credit scores, it is conceivable that using your debit card will affect your “credit.” However, the effect is most likely indirect. That is, most alternative credit scores look for overall financial responsibility; they want to see that you can avoid overdrawing your checking account and live within your means. Spending too much will cause problems because you’ll eventually bounce checks and be unable to pay important expenses like utility bills.
Alternative credit scores don’t look at how you use your debit card, but they may look at things like electricity payments, rent payments, and mobile phone payments. To look good under those programs, you’ll need a history of consistent and timely payments. You’ll only pull that off if you can manage your checking account, so your debit card is involved.
In addition to paying bills on time, it’s essential to avoid bouncing checks—even if your payee doesn’t report to any credit agency. Some “alternative” lending decisions may be made based, in part, by looking at your ChexSystems report, which banks use to track bad checks. What's more, bad checks eventually may be turned over to collection agencies, and those debts will show up on traditional credit reports and damage your FICO score.
What about the future? It’s possible that FICO credit scores will change. At some point, FICO could track the use of debit cards in the credit scoring model. More and more people rely on debit cards, partly because they want to avoid borrowing on credit, and partly because they can’t qualify for a credit card. So, there’s one more reason to use your debit card wisely.