Young people’s fear of credit cards and lack of financial knowledge could have long-term consequences, according to a recent study by student loan refinancing company lendEDU.
In the study, 500 millennials, ages 17-37, were asked questions about their credit score and how credit works. Forty-four percent of respondents incorrectly said they could increase their credit score by increasing their amount of debt, while only 17 percent knew they could improve their credit score by decreasing their overall debt. Fifty-eight percent said they had a low or fair credit score.
Assistant Professor of Business Jody Jones said those with a low credit score will pay for it over time with high loan interest rates. The difference between a low and high interest rate can add up considerably on large loans like a house payment, Jones said.
“Your credit score is a mathematical probability of you paying your loans back,” Jones said. “The higher the probability you’ll pay them back, the cheaper the interest rate is. Someone can go and buy a house with a 600 credit score and get an interest rate of about five percent. For someone who has a 700 credit score, they can buy a house and get an interest rate of four percent. Over the life of the loan, it’s a $100,000 dollar difference.”
According to Jones, the best way for college students to build credit is to responsibly use a credit card and pay back the full balance monthly. Jones said frivolous purchases will often lead to increased interest rates and a lower credit score.
“Getting a credit card which you pay off every month really helps your credit,” Jones said. “The key is you need to pay it off every month. Don’t use it to go buy dinner or Thunder tickets you can’t afford. Russell Westbrook will be retired in seven or eight years, and you’ll still be paying for your tickets with interest.”
Thirty-six percent of respondents in the lendEDU poll believed they could increase their credit score by maxing out their credit card and making timely payments. According to Assistant Professor of Finance Daniel Sorensen, maxing out credit cards will send a red flag to lenders, causing credit scores to decrease.
“The credit bureau considers it to be a danger point if you start hitting 60 or 70 percent of your max available credit,” Sorensen said. “It’s a red light, which will start hurting your credit score. Maxing out your credit cards won’t help your credit score. Paying off your credit cards like clockwork will.”
Sorensen said students should see credit cards as a tool for building a credit history. Credit history makes up 15 percent of the total credit score, meaning those with a short credit history will see their overall score take a hit.
“I tell students in my personal finance class, you do in fact want to have a credit card as a student,” Sorensen said. “Having a credit card will help establish a credit score and a length of history. If you only have three or four months, it’s not a very long credit history. If you have a card for two or three years, you’ll have a long enough history, and your credit score won’t be affected.”
Some experts say the thought of having and using a credit card has scared millennials, a generation which saw firsthand the consequences of the 2008 financial crisis. A 2013 SallieMae poll found just 30 percent of college students used a credit card while in school. A 2017 lendEDU poll showed 41 percent of millennials see credit cards as intimidating.
Complicating the relationship between credit cards and millennials is the passing of the Credit Card Accountability, Responsibility and Disclosure Act (CARD act) in 2009. The act prohibits lenders from issuing credit cards to young adults under the age of 21 without a cosigner or proof of regular income. There is also a provision under the law barring banks from marketing credit cards and giving away free gifts on college campuses.
According to the American Banker’s Association (ABA), the law has adversely affected college students wanting to build a line of credit.
“The CARD Act has yielded significant negative consequences for consumers,” the ABA said in a 2015 statement. “Credit card credit is less available, particularly for borrowers who have limited credit histories or are new to the workforce, including young people and immigrants.”