A recent study conducted by TransUnion found that millennials had lower credit scores than Generation Xers did at the same age.
As a millennial, my first instinct was to react a little bit defensively to this one. I feel like our generation is over-analyzed, and it can lead to some misconceptions about our work ethic. We’ve even been accused of killing entire industries based on our habits.
I’m not saying there aren’t things we do differently than other generations; I just think it’s dangerous to make rash generalizations about people of any age group (well, of anygroup).
As I read further on this study, I realized that a lot of the findings of the researchers do resonate with me. Some of our habits we’ve tried to maintain with the best of intentions could actually hurt our credit worthiness, which affects your ability to lease a car or buy a house.
Each problem affecting the creditworthiness of millennials is also something we can begin to address or – in the case of large debt, like student loans – at least understand the impact and prepare for a solution.
Let’s discuss two things millennials have been doing, for very sensible reasons, that may actually be hurting their ability to get approved for loans: avoiding using credit cards and borrowing student loans. We’ll take a look at each and then see what they can do to get on the road to great credit.
Bad Credit? More Like No Credit
Millennials don’t necessarily have a bad track record when it comes to handling debt. In fact, many of us came of age during the housing crisis of 2008. Seeing our parents and relatives struggle, many of us took a very sensible vow to not purchase anything we couldn’t afford. The problem isn’t the vow itself but how we went about implementing it in our lives.
Instead of using credit cards and loans to purchase items, we’ve only paid for things directly out of our checking accounts. Debit cards made it just as easy and convenient to buy things online as did credit cards. Debit cards also have the benefit of not allowing you to carry any debt because you’re buying only what you have the money for. (Not overspending is always a good thing.)
However, there are certain things in life, like a house or a car, that most people who aren’t independently wealthy can’t afford to pay for with cash. That’s where the extension of credit and loans comes in.
The problem for many millennials is that you’ll likely have a hard time obtaining a line of credit or a loan if you’ve never taken the time to open a credit card and show that you can responsibly manage it. A lender is unlikely to give you money if they can’t see some record of how you’ve handled money in the past. This is identified as a major problem in the TransUnion study.
Perhaps you’re not clear on how personal finance works, but it’s always a great time to learn – better late than never! So, what’s the best way to establish credit? Let’s dig in.
Strategies for Establishing Credit
If you’re in your 20s and you don’t have a credit card, it’s probably a good idea to apply for one. In most cases, the only thing you’ll be able to get is a secured card.
The way these cards work is that you use some amount of your own funds in order to set them up. For instance, if you put $1,000 in this account, you would have $1,000 as your credit limit. If you make your payment every month, that credit line never goes down. Whenever you close that account, you get your initial deposit back. In some cases, after a while, your lender may be willing to transition this card into a more traditional unsecured card (one that does not require a deposit).
It’s worth noting that normally we wouldn’t suggest closing any credit cards but rather spreading your spending between them. The reason you might close a secured card is that sometimes banks charge you a monthly fee to manage it. Once you’ve been able to open two or three unsecured cards, consider closing the secured card to have a minimal impact on your score. One positive outcome of having multiple cards open at once: Lenders look to see if you’re able to responsibly manage multiple loans and lines of credit.
You’re more likely to be approved for a mortgage if lenders can see that you have a mix of different types of debt. Credit cards are referred to as revolving debt – the amount of debt you have changes every month based on your spending and payments. Then there’s installment debt for things like car loans or student loans. I buy certain things in installments, when it’s an option. This way, I can vary my credit mix.
My personal credit card strategy: I like to treat my credit card as if it’s a debit card. I put everything I can on it and pay it off at the end of the month. This allows me to not only build up credit without ever paying interest, but also to take advantage of all the rewards points, which I use to redeem things like gift cards. It’s like getting my own Christmas gift every four months or so.
It’s generally a good idea to avoid utilizing any more than 30% of your credit limit at any given time, in order to negatively impact your credit score. Read more about tips on building credit.
The other thing that makes qualifying for a mortgage, or any other kind of loan, harder for young people now than those of previous generations is that we have lots of debt from attending college. According to the most recent available statistics, the average college graduate in the class of 2016 had $37,172 worth of student loan debt.
Unlike debt that goes to pay off an iPhone or a hot tub you splurged on, college is more of a need these days than a want, and with that comes student debt.
Although you may feel like you don’t have any options about what to do with your college debt, you can educate yourself as to what it means for your home loan process.
Student Loans and Your Mortgage
If you’re attempting to qualify for a mortgage while paying off your student loans, your monthly student loan payments are included in your debt-to-income ratio (DTI). DTI measures how much of your monthly income goes toward paying off debt. This is how mortgage lenders, including Quicken Loans, determine the amount you can be preapproved for when you’re getting ready to go house shopping. How your loans are factored into your DTI for a mortgage will depend upon the type of loan you’re applying for.
If you have fewer than 10 months remaining on your student loan payments, you can exclude your student loan payments from your DTI under most mortgage options. If you’re getting an FHA loan, the cutoff is nine months or fewer.
So is it harder for millennials than previous generations to get a mortgage? Maybe we have a few more hurdles than others do, but it certainly helps to be prepared. If you’re ready to buy your first home, you can get started online or you can give me a call or text at 334-436-0237 or at the Office at 334-863-2244.