This article was written by Joe Bayen, CEO of Lenny.
Remember those carefree college days, when your biggest worry was scraping together the funds for a frat-house kegger, or the stress of an all-nighter to make that big deadline? Perhaps it doesn’t seem so long ago, the freedom of campus life, the wild parties, and as time went on, the looming prospect of the real world. Just years later, most graduates feel the pinch of student days gone by — and many are experiencing reeling debt and dwindling credit scores.
During times of austerity, a post-recession generation is mistrustful of credit. But as college fees soar, today’s graduates fall victim to unimaginable loan repayments, and these poor money habits cast a shadow over their financial futures. This doesn’t mean that the frugal student needs to completely abstain from spending. But it does call for a lesson on credit.
Seven out of ten millennials say they are confident about their credit knowledge, yet their flailing credit scores beg to differ. But fear not, it isn’t too late for today’s young professionals to turn this around. So what can millennials do to fix their futures? Let’s take a look at the situation.
The cost of an education
Despite the free gym membership, a proliferation of student discounts and happy hour at your local dive bar, you still ended up with a hefty debt. Maybe this comes at no great surprise, but did you know that while the average cost of education continues to rise, the corresponding earning potential does not follow suit?
The Huffington Post recently compared recent graduate salaries over 25 years, up just 1.6 percent when adjusted for inflation, with average student debt, which has grown by a huge 163.8 percent. Was it all worth it? Ignoring the social benefits and the experience of attaining higher education, thinking just purely financially, for the average student this is debatable.
Successful graduates in the class of 2015 last year finished college with a projected average debt of $35,000. As this debt rises, the proportion of students taking out loans is also increasing, and a large number of these people are not handling this enormous debt in the best way.
The Consumer Financial Protection discovered that 94 percent of people taking out FFEL loans do not use income-driven repayment plans (IDRP). This type of plan helps those who are eligible by letting them pay a smaller percentage of their discretionary income, and if this income comes below a certain threshold they can even put off payments altogether.
Payment plans like this exist to help graduates in times of financial difficulty, instead of relying on emergency loans or the bank of Mom and Dad. However too often they are neglected. It seems we have picked up some poor money habits, and these behaviors can be traced back to those good old college days.
Why borrowing money is smart – when done correctly
In 2009, the CARD Act changed the way students could apply for credit cards, preventing many under-21s from accessing credit. The idea was to ensure “fairness, transparency, and accountability”. However a by-product of this was that through making it harder for millennials to get their hands on credit, it also drove the attitude that credit is bad. As a result, we have not only become overly wary, but also ignorant of the benefits of borrowing.
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63 percent of millennials today don’t own a credit card, according to a survey from Princeton Survey Research Associates International, in collaboration with Bankrate. Many report that they don’t understand the purpose, when they already have the cash. And when they don’t have the cash, they are worried about making commitments. Millennials are paying for this with the worst credit scores of any generation today.
So, what factors influence your credit score? A number of different indicators are important; 35 percent comes from your payment history and evidence of making payments on time, 30 percent is from your credit use, 15 percent comes from the length of your credit history and 10 percent is determined by the type of credit you have. Having no credit history doesn’t mean you are good with money, it means you are a risk for lenders, but you can control this through the smart utilization of credit.
While any student that has borrowed already has a credit rating, understanding credit and using cards means you can control your credit rating and start to build a record. By making small, easily repayable purchases without incurring interest you start to build a presence.
Credit cards also offer a more secure way of paying, and many benefit from a number of cash reward schemes, for example when buying gas or groceries. When used correctly these can actually help users to make big savings.
Planning for the future
Re-programming our relationship with credit is just the first stage on the road to a better financial future. Putting in place measures to actively build your credit score will positively impact your ability to enter into contracts, such as cell phone plans and renting. It will also help you further down the line, when applying for larger loans like mortgages, and can reduce the interest you will be required to pay.
Millennials today are postponing life events like weddings, buying a home and starting a family due to these money concerns. 56 percent of Americans between the age of 18-29 with student loan debt reported delaying a life event for this reason, according to a survey from Bankrate.
Unfortunately, despite being more qualified than older generations, millennials today still struggle with job insecurity, and frequently end up worrying more about the immediate future than the distant dreams of retirement. However, amid this uncertainty it is pretty much guaranteed that one day you will want to retire. Paving the way for this means taking advantage of instruments like emergency fund savings and pension schemes. No it isn’t sexy, but investing in plans such as these secures your future and can define what will be possible.
If you don’t have an emergency fund, you’re not alone. Only 47 percent of millennials have put money aside for the future. But in contrast to other generations, 83 percent of this generation has put into a pension plan. We are making good use of retirement plans such as a 401(k), 459 or 403(b). There is hope for us yet!
Years after graduation, your college reunion will no doubt consist of old classmates polishing off and announcing their greatest achievements. It’s unlikely your fellow alumni will be competing over credit scores. However, a few smart financial moves – while admittedly not the most glamorous sounding life decisions – will help to enable these accomplishments, and could make all the difference down the road.