Credit cards – can't live with them, can't live without them
At 24, Josh Waldron thought he was ready to buy a house. He paid off his college debt, only two years after graduating. He saved enough for a down payment. All in all, he and his wife were ready to leave a life of renting behind.
Then his plans ground to a sudden halt. Waldron’s credit score had disappeared.
“How did this happen? It just didn’t make sense to me that I’d have a nonexistent score,” says Waldron, who is now 28. He had applied for a mortgage loan a few months earlier and found his credit score to be a robust 718.
So what happened? How could a person who was financially responsible and paying his bills on time just wake up one day with no credit score?
The culprit turned out to be his debit card. Waldron, eager to avoid debt, used his debit card to pay his bills and buy what he needed. He had never used credit cards.
The catch: no credit cards meant no credit.
Since Waldron applied for mortgage more than six months after he paid off his student loans, his credit score would not be generated, says myFico.com spokesman Anthony A Sprauve, because his “only activity in the last six months is using a debit card, and debit card usage is not reported to the credit bureaus.”
Waldron is not the only millennial who has hoped to make a go of it without a credit card. According to recent FICO study, in the last seven years the number of those 18-29-years-old living without a credit card increased by 9%, going from 7% in 2005 to 16% in 2012.
Ken Lin, CEO of Credit Karma, sees cases like Waldron’s – called “thin files” within the financial industry – all the time.
They are extremists. You can have a credit card and not carry interest. Pay them off in full. Otherwise, it becomes a bad situation when you want to buy a home. That’s when you get in trouble. No one will underwrite you.”
Having a FICO score – that key to financial maturity – requires having at least one account that reported to a credit bureau in the past six months. Yet a lot of millennials are walking around among the other 50 million people with no credit score, and thus, no access to credit.
What makes it worse is that anyone under 21 is 18% less likely to get a credit card, according to a study on young borrowers by the Federal Reserve Bank of Richmond. Under the Credit Card Act of 2009, anyone under 21 cannot be issued a credit card without a co-signer or proof of a job; creditors want evidence that card holders can repay potential credit card debt. The act also prohibits credit card companies from soliciting students on campus.
“Has it become harder to build a credit score within the last five years? Absolutely,” says Lin.
This is especially true for millennials, who have on average the lowest credit score of all different age demographics. Sprauve attributes this to the fact that compared to other generations, millennials are young, and so they have not had as much experience with managing credit. About 15% of a FICO score is determined by the length of your credit history.
Millennials tend to learn fast about credit. The Federal Bank of Richmond found that 18-25-year-olds with credit cards actually learned from making mistakes early on. They became less likely to have a serious default on their cards, and more likely to bet on good credit risks later in life.
Millennials are also not using many types of credit. Car loans and mortgages are largely out of the equation as the recession has resulted in “failure to launch”. Unfortunately, millennials don’t have much say in the matter, not the least because they have higher than average unemployment. Not only are they not buying homes or applying for mortgages, but 53% of 18-24-year-olds, 41% of 25-29-year-olds and 17% of 30-34-year-olds have moved back home and are currently living with their parents. For the first time since 1963, the percentage of 16-24-year-olds with a driver’s license has dropped below 70%.
Millennials aren’t buying cars or homes, and as a result, many are non-entities to the financial industry.
“If millennials are staying away from credit cards, auto loans and mortgages, it will be very challenging to generate a FICO score,” says Sprauve.
There may be a solution brewing in Washington, in the form of the Credit Access and Inclusion Act, which has been submitted to the House committee on financial services. The act would allow payment histories on non-loan accounts such as rent and utilities to count towards your credit score.
However, experts fear that bills such as this might backfire. Instead of helping boost or generate score for consumers, reporting of such payments might hurt them because it’s so easy to fall back on rent or utilities.
When Waldron applied for mortgage, he was told that consumers like him, without credit scores, were considered risky. In the end, he got the mortgage, with slightly higher down payment, and bought a home in Virginia. He has also since obtained two credit cards – one for personal use and one for his web design firm, Studio JWAL.
“I knew since high school that you are supposed to have a credit card. That wasn’t what surprised me,” he admits. “What surprised me was that all the other things I was doing, being responsible, weren’t enough to help me build credit.”