Millennials: A Generation Failing at Credit Management, or Not?
If the recent Experian report is anything to go by, millennials are not as efficient as the last generation when it comes to credit management. Giving an insight into fairly poor credit management capabilities, the report reveals that, on average, millennials have a low credit score of 625, whereas the figure for Gen X is at 650, and Baby Boomers together with the Greatest Generation (older than 50 years) were reported to have an average credit score of 709.
To secure a financially stable future, it is important for millennials to raise their credit score, which is only possible if they are aware of the finer lines of credit management, and that’s precisely what we have tried to achieve with this brief post.
Why are Millennials Failing Financially?
A recent poll by Allstate/National Journal Heartland shows that nearly 3 out of 10 Millennials find paying off student loans as their biggest financial challenge. Many millennials owe larger-than-life education loans, repayment of which is beyond their earning. Taking inflation into account, in most cases, millennials have to pay back about twice, compared to borrowers two decades ago. In 1989, the bottom three-fifths of individuals in the age group 18-34 had an average net worth of $3,000, and in 2013, the same group had a net debt of $7,700.
Thin Credit Files
Millennials have thinner credit files than the earlier generations, as surprisingly, they are not too inclined on plastic money. In 2015, only 27 percent of millennials opened credit card accounts, whereas, the same year, approximately 46 percent of Generation X opened their accounts. A study by CreditCards.com shows that 36 percent of millennials have never opted for a credit card. As most Millennials have a thin credit file, any skipped payment or high credit utilization might cause severe damage to their credit score.
Is There A Need for a New Credit Score System?
Millennials are expected to hit 75.3 million and surpass the population of baby boomers in 2015. While the growing size of millennials makes them a key segment of society, their increasing debt to income ratio is a matter of concern. So, does this mean we have reached the end of the line? More importantly, can a new credit score system solve the problems of millennials? Here are two reasons that make us feel strongly about the new credit score system:
Millennials Have Different Spending Habits than their Predecessors
This generation loves to spend more on organic products or buys a new car instead of repaying home mortgage debt. Auto loans, for example, have a 14 percent share in the recently opened accounts for millennials, while it was restricted to only 1 percent when Generation X was of the same age in 1998. In short, the existing credit score system doesn’t sync well with the spending habits of millennials.
We still Follow the old FICO Model
FICO model originated in 2004, includes the data from 1995 to 2000, and the major credit bureaus still consider it to calculate a credit score, to decide the eligibility of an individual for a loan. It is important to understand that while consumer behavior has changed and more granular data is available, sticking to the same old model that was incorporated into the automated underwriting engine 20 years ago isn’t a smart thing to do.
Nonetheless, as a complete revamp of the credit system is nowhere on the cards, here is an overview of the FICO model to help you understand how credit works:
The payment history of an individual gets 35 percent weight in the credit score. Millennials have a short history because of their age and the fact that they get access to credit cards later than the earlier generations, results in a disproportionate impact on their credit score.
The amount of debt an individual owes accounts for 30 percent of the credit score. Millennials often have credit cards with low limits, which means they are more vulnerable to max-outs, and it brings their credit score down, irrespective of whether the payments are made on time.
The credit history accounts for 15 percent of the score. Credit Card Act of 2009 and the recent recession has made it harder for Millennials to own a credit card and if they get one, it might have a short history.
In Need of a New Credit Scoring System
Millennials are actively seeking credit, but many are being turned down due to a low credit score. FICO has already announced that it will soon have a new credit scoring system that will honor timely payments of electricity, gas, cable, and cell phone bills. This, however, may not completely solve the problem.
We also need to have a system that fetches data from online lenders and marketplaces wherein Millennials are establishing credit relationships. It is essential to introduce a new scoring system based on the lending and borrowing behavior of millennials.
To learn more about how to raise your credit score, please feel free to contact us for a no-obligation consultation.