The debit card looks like the perfect financial plastic: all of the convenience of a credit card, without any of the risks. You can't spend more than you have in your bank account with a debit card, so there's no need to worry about racking up crippling credit card debt and getting slammed with 20-30%+ interest rates.
Those are true facts! In the younger age groups especially, people are eschewing credit cards and using their debit cards for everything. But are there any downsides to this trend?
A debit card is a good idea if you have a problem of overspending your limits. For everyone else, paying with a credit card is the better option. The reason: credit history and credit scores.
Your Credit Score
Banks use your credit score to decide the terms of loans extended to you: that is, how much money they'll give you and what the interest rate and terms will be. The better your credit score, the better your loan terms. Lower interest rates, especially on something substantial like a home mortgage, can save you many thousands of dollars over the life of the loan, so a good credit score is worth striving for.
This article discusses exactly how your FICO score, the most common measure of credit worthiness used by banks, is actually calculated. In general: assuming you don't have late payments, the longer your credit history and the more credit you have, the higher your score will be.
This presents a bit of a Catch-22: the best way to get more credit is to have credit!
The Debit Card Flaw
Having and using a credit card helps build your credit history and establish your creditworthiness.
Having and using a debit card does absolutely nothing for your credit score.
If you don't have credit cards and you've never taken out a loan, you won't have any score at all!
Without a credit score, it's exceedingly difficult to get a loan or other forms of credit.
Getting Started With Credit
Find a bank that is pleasant to deal with and has no fees, like a local credit union. The credit card they offer you probably won't have lots of fancy perks attached, but that's not the point. Apply for this card, receive it, use it, and never cancel it. In addition to getting your credit history started, this card will also establish your credit age. If you keep this card forever, this account will always appear on your credit report and your credit age will always be the number of years that you've had this card. Credit age accounts for 15% of your calculated credit score, and a higher credit age is better.
Once you get that first card set up, monitor your credit score with a free service like CreditSesame and request a free copy of your credit reports from AnnualCreditReport.com. When your score is sufficiently high, consider applying for credit cards that offer cashback in categories that are relevant to you.
And that's all it takes!
Spend a little time building your credit today, and you'll get the best interest rates and loan terms possible when you do eventually buy that house or start that business.