We as a nation have done an incredible disservice by not properly explaining to young people the importance of credit, and because of that, an entire generation has grown up not understanding the effects of credit, let alone the proper use of it. Millennials are left to fend for themselves without any knowledge of how borrowing on credit truly works; and if they are not aware that they are missing this knowledge, it is hard for them to fill that information gap they have.
The lifestyle that many of this generation prefer to lead is also affecting their credit, but Millennials do not comprehend how they are hindering themselves from getting what they need, or will come to need, in the future. Hopefully, we can clarify and educate this generation on some of these issues, and help some of them set themselves up for success.
Freelancing: Good or Bad?
For freedom and flexibility in their lives, it can be good. For credit however, it is bad. Millennials have a tendency to prefer freelancing gigs over the typical company employment model of work. This can be a great way of earning additional income to supplement a regular paycheck, but as a primary form of revenue, freelancing is hurting their ability to receive credit.
Loan providers, including credit card companies, want to see an uninterrupted work history that provides a steady source of income; they want to see that a borrower can afford to repay a loan or be able to afford a monthly credit card bill.
The nature of freelancing does not allow for a steady paycheck. While some gigs may prove lucrative, this is not always the case. There may be long periods between projects where there is no money coming in. Lenders tend to shy away from work histories with extensive breaks in between. Basically, there is no guarantee of income, and that makes the potential borrower a risk – one that they are more than likely not willing to take.
Break Through the Stigma of Credit Cards
The Millennial generation grew up seeing their parents working long hours, missing out on activities so they could support the family, only to struggle to make ends meet. Because of this, Millennials are hesitant to use credit cards for fear of falling into the same cycle. They do not want to work only to remain in debt. While this is understandable, they are going about it all wrong. Instead of avoiding the use of credit cards, Millennials should learn how to manage credit card usage.
Current credit utilization standards suggest that a person should use no more than 35% of their available credit at any one time. This includes credit cards and other forms of revolving credit, such as personal loans. Millennials need to monitor their spending, as does anyone of any generation, but they can’t be afraid to use their cards more often.
By charging a balance on their credit cards, and paying the balances off at the end of each month, they can add positive reports to their credit histories. This in turn will improve their credit scores. Doing this will increase their ability to receive additional credit like a car loan or a mortgage when it comes time for them to buy a house.
Hard Inquiries are Hard on Your Credit
Millennials do not fully understand how credit histories and FICO scores work. They do not know what goes into a person’s credit history and how certain things can negatively impact their credit score. As I discussed above, work history is one of the things the credit reporting bureaus collect. An individual’s credit utilization ratio is another aspect of the report.
Hard inquiries are a third. This is where a lender pulls a copy of a person’s credit report and score when an attempt is made to take out a loan or open a revolving line of credit. Regardless of the outcome of these inquiries, they still affect the credit reports.
As with all young people of any generation, Millennials want to have the best car possible; they want the sleekest design with the best speeds. When shopping around the various car lots, they will attempt to purchase a vehicle that fits this description, ignorant to the price of the car or the process involved with receiving an approval for it. If they are denied, they will move on to another car lot and make another attempt.
Each time this happens, each of the lenders involved are pulling the buyer’s credit report. This puts a hard inquiry on the report. Too many inquiries show lenders that others have denied the buyer a loan, leading them to deny the person as well. These hard inquiries also lower the Millennial’s credit score.
Instead of going for the hottest car on the market, they should try to buy a more practical car, with a price far lower than the speedster they were wanting. A lower price tag reduces the size of the monthly payments, bringing the buyer’s ability to repay the loan more in line with the lender’s terms. This could help lead to an approval for the car and prevent so many hard inquiries from hitting their credit report.
Every Step You Take Can Lead to Financial Flexibility
Without a steady job, Millennials are preventing themselves from having their own home. Some may not be interested right now in owning a house, and that is perfectly fine, but they are not considering the future and how desires change. They need to focus on building their credit. This starts with constant employment, and creating a work history lenders will be comfortable with.
Opening a credit card is a good way to start creating that history that lenders can use to make decisions on future requests. By using them smartly, staying within the 35% credit utilization ratio, and paying off the balances each month, they can turn their fears of credit cards into their advantage.
Millennials should keep their hard inquiries to a minimum by being smart about their purchases. Maintaining sensibility over frivolousness can help keep the inquiries down, helping to improve their credit histories and credit scores. Improved credit scores will allow them to have the financial flexibility that can only be achieved with effort and patience.