Forty three percent of Millennials currently have subprime credit, which means their credit score is situated somewhere between 550 and 620. This is surprising considering the fact that, in the Digital Age, information about how to keep a solid credit rating is everywhere. While subprime credit isn’t viewed by creditors as abysmally low, it does set up an entire generation for higher than average interest rates, annual fees, and application fees. In short, Millennials are poised to pay more for anything they choose to purchase via credit.
Certainly, humanity has managed to survive prior to credit cards and credit scores. However, unless you’ve inherited -- or are about to inherit -- a large cache of cash, purchasing a home, or anything requiring an enormous amount of money, is largely dependent on your credit score. Need emergency access to money? It will be an uphill challenge with a subprime credit score.
Why is there a credit score divide between Millennials, Generation X, and Boomers? Part of the reason stems from the merging of a younger generation under the “Millennial generation” umbrella. The source of the 43% statistic is a TransUnion report that uses the VantageScore rather than the FICO score as the credit score metric. TransUnion chose an 18-year generation span for both Millennials and Boomers. This adds three more years of births to the two “largest” generations. Statistically, their sample sizes are skewed.
As generations mature over time, their credit scores improve. Life experience combined with an increase in becoming more conservative about risk taking is a key psychological factor as to why the older generations have better credit scores. The Millennial group indicated by TransUnion includes three years of a younger generation who is just beginning their credit history. Once again, this skews the average of the Millennial credit score down. Meanwhile, the Boomers have the advantage of three extra years of an older, more established generation skewing the average credit score to a higher number.
There are, however, additional factors regarding Millennial credit usage that inhibit achieving a higher credit score. Notably, Millennials use 79% of their maximum available credit. Granted, all of the generations use over 50% of that maximum. But, since Millennials currently have the least available to them – a side effect of being younger and still establishing a long-term credit history – this is a glaring differential. One of the factors both VantageScore and FICO use for calculating credit scores is how much of their available an individual (or a group) uses. A higher percentage is viewed as a higher risk for the extension of credit.
Additionally, there is a disparity between the types of credit each generation uses. Millennials are more likely to have auto loans and revolving lines of credit. Meanwhile, they’re less likely to have a mortgage. At first glance, the percentages appear to be only slightly different if you compare Millennials, Generation X, and Boomers. The large exception rests on mortgage loans.
Revolving credit cards and auto loans aren’t equity generating financial tools. This is not to say that they can’t be used in that manner if a financially savvy individual is wise about when, where, why, and how those types of credit are utilized. Purchasing a home is, definitively, an investment. Despite the economic crash of 2007/2008, real estate tends to increase in value over time. Summarily, at some point in the future, the property is worth more than you initially paid for it. Such is not the case for an automobile. The moment you drive a shiny new car off the lot, it depreciates in value (sometimes drastically).
Most credit card purchases are for items that also tend to greatly depreciate in value. Of course, if you’re buying rare coins, baseball cards or other collectibles, depreciation versus cost isn’t entirely lopsided. But, arguably, it takes a longer period of time to reap the rewards of the investment; that is if you ever decide to sell the collectibles. Even then, real estate still wins when it comes to maximizing your returns on credit usage.
The catch-22 is, if you have a large number of revolving credit lines and a high proportion of credit usage in relation to your maximum available credit, then this can impair the ability to secure a mortgage. Real estate prices are increasing, and banks aren’t loosening their “percent down” rule (unless you have stellar credit and other financial factors, 20% is still the golden measurement for a down payment on a home).
To turn this around, it’s important for Millennials to pay down their credit cards and make sure they pay their auto loans on time. Also, there’s generally no need to switch to a new car every few years. Once the auto loan is successfully paid off, keep the car and funnel that car payment into a financial tool where you earn interest. Before you know it, your credit score will improve, and you’ll have ample savings to meet the down payment requirement for a home.
Millennials have time on their side when it comes to credit score improvement. But, it will take patience and wise use of the credit that’s currently available.
