Credit Q&A: Debit and Prepaid Cards

There’s no shortage of information available about best practices for managing your credit. Unfortunately, some sources are less reliable than others, and some “facts” have been distorted into widely believed misconceptions – like financial old wives’ tales.

Here is a commonly asked credit-related question and answer that will put you on the right track for sensible credit management:

Question: Does using a debit or prepaid card improve my credit score the way responsible credit card use does?

Answer: No.

While debit, prepaid, and credit cards may look alike on the outside, debit and prepaid cards draw on existing funds while credit cards extend a revolving line of credit that must be paid back. Because purchases made with a debit or prepaid card are paid for immediately by direct deductions from your bank account, or from funds loaded onto the card, there is no need for credit to cover the expense.

Credit bureaus are interested in behavior attached to a line of credit such as the one offered by a credit card. In fact, only account balance and payment history of a credit card or a secured credit card will be reported to credit bureaus. Your credit score is affected by actions that demonstrate your reliability as a borrower – things like how consistent, how much, and how timely your credit card payments are.

It’s also important to remember that although it might seem “safer” to avoid credit cards entirely and make all your purchases using a debit card that draws from your bank account, having no credit history can also be damaging to your ability to get credit now or in the future. There is a balance to be struck. The smart choice is to diversify your methods of payment – debit card and credit card.

Secured Cards — A Credit Building Alternative to Debit and Prepaid Cards

A secured card offers a credit option that acts very much like an unsecured credit card with regard to how it can help you build and improve your credit. The key difference is that you provide a security deposit that will serve as the basis for your line of credit. The minimum and maximum amount of the credit line you can secure depends on the card issuer.

Purchases made with a secured card will draw against your revolving line of credit.  When you make payments to your account, your available credit will increase again, just like with an unsecured credit card.  Also, because your payment behavior is reported to the major credit bureaus, you will want to make at least your minimum payment every month on time. Not only will this contribute to establishing your credit history, but in some cases the issuer may extend you additional unsecured credit in return when you have demonstrated responsibility as a borrower.

For these reasons, if you can’t qualify for an unsecured credit card, secured credit cards can be a great alternative to debit or prepaid cards.

Look for more credit and money management questions and answers in the coming months.

 

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