There’s a Catch-22 in the millennial credit world. Fewer millennials are applying for credit cards when compared with prior generations, but staying debt-free for too long can make it difficult to borrow in the future.
Getting a credit card helps establish a credit history, telling lenders how reliable a potential borrower is in paying back a loan.
“By not having any credit cards or student loans, I didn’t have a credit report or credit score,” recalled Allen Walton, a 27-year-old entrepreneur. “I effectively didn’t exist to anyone looking me up.”
But to avoid becoming a member of the “credit invisible” generation requires careful planning and financial responsibility to know when is the best time to apply for a credit card and how it will meeting your needs.
Credit rejection
Before Congress passed the Credit CARD Act of 2009, college students were deluged with offers from banks, enticing students with easy credit and loads of goodies to sign up. The law now requires anyone under 21 to either have a co-signer or show proof of income — in effect, preventing young people who may not be creditworthy from getting their hands on a card and running amok.
The law is likely one reason millennials don’t appear to be in any great rush to slip that very first credit card into their wallets. A recent survey by NerdWallet found that 31 percent of people aged 19 to 34 had never even applied for one.
Another possible reason is that millennials have been frightened off by horror stories about crippling debt.
“Many of them — like myself — entered the job market during the downturn, so it’s really caused us to think twice about money. Additionally, millennials probably feel like they have enough debt to worry about thanks to student loans,” said business coach Amanda Abella. “I think it’s a mix of misinformation and fear surrounding credit. They are afraid of getting themselves into any more debt than they are already in.”
Walton, who started the website SpyguySecurity.com, an online seller of security equipment, was one of them.
“I didn’t have any credit cards until one year ago. I loved the fact that I was debt-free,” he said. “But this caused all sorts of problems for me later in life. By not having any credit cards or student loans, I didn’t have a credit report or credit score. I couldn’t get approved for my own cellphone plan. I couldn’t get a loan on a used car that cost $25,000 even though I was putting down $15,000 in cash.”
Ironically, many millennials like Walton are finding the credit system can penalize those who stay debt-free for too long into adulthood. During a six-month period in 2014, roughly 40.5 percent of millennials with credit scores between 300 and 579 applied for credit cards, according to research from Fair Isaac Corp. and as reported by NerdWallet and other outlets. Only slightly more than 16 percent opened new accounts, suggesting many applicants were rejected.
A low credit score is not the only reason for rejection. Many young applicants may be aiming for lines of credit that are out of reach. According to a recent Experian analysis, millennials have the lowest average credit score — 628 — when compared to previous generations. That’s hardly a score to command a premium card.
“It seems that millennials are trying to take on a level of credit they don’t fully understand,” said Gerri Detweiler, director of consumer education for Credit.com.
“Popular cashback, rewards and airline miles credit cards frequently come with high interest and some even charge an annual fee. Banks generally require good to excellent credit ratings for approval for these cards,” added Bethy Hardeman, chief consumer advocate at Credit Karma. “Unfortunately, millennials may be seeing these cards advertised and applying without first understanding their credit.”
And being rejected for a credit can do more than just bruise the ego, Nerd Wallet noted. “Each of these failed applications hurts the applicants’ credit scores, perpetuating a vicious cycle,” its survey said.
What kind of card?
The first thing any consumer should do when considering a credit card is to determine what sort of card best fits them.
“You have to know yourself,” said Detweiler. “Are you organized? Look at your experience with money. Do you tend to save or spend? If you tend to spend, it might not hurt to wait.”
For those ready and responsible enough to establish a credit history, there are several options. One is a “student card” — credit cards available to students with little or no credit history. To qualify, students need proof of some form of income or have a co-signer.
Another choice is “piggybacking” — asking a parent or other relative to add the student’s name to their account. Just make sure the card holder has a good credit history since that can reflect on others who have signed up for the account.
One of the most reliable methods of obtaining a card and building a credit record is a secured card. Unlike conventional credit cards that offer an autonomous line of credit, a secured credit card uses money placed in a security deposit account as collateral. The credit line is based on income, ability to pay and the amount of the cash collateral deposit — for instance, a $1,000 deposit entitles the user to a $1,000 credit line.
Secured cards are not the same as prepaid cards. With a secured card, the user is responsible for paying anything charged on the card like any other credit card, and that is a credit history. A prepaid card taps into deposited funds when the card is used, which does not create any credit record.
Although he was late to the party, Walton said a secured credit card was key to ultimately building a solid credit record.
“You stay out of debt, you pay nothing to get the card, and your credit score goes up,” he said. “My personal score went from nonexistent to 650 to 700, and then all the way up to 798 using this.”
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