Credit 101 for Millennials: The Importance of Establishing Credit Early

Not establishing credit at a young age will have a negative impact on your overall credit as you get older and will cost you thousands of dollars.

A lot of young people walk around with the mindset that they’re young and because they just graduated from college and started their careers that they shouldn’t worry yet about saving for retirement or having a good credit score.

They think it’s not necessary for them to focus quite yet on making smart financial decisions.

This couldn’t be further from the truth.

Your 20s are the most important financial years of your life.

Many of us don’t understand how the financial decisions we make today will impact us years down the road.

Unfortunately, these are also the years that we know the least about managing our money because for many of us it’s the first time we’ve ever had to do it on our own.

I had credit long before I even knew what that meant because I’ve had student loans since I was 18.  It’s taken me several years to truly understand just how important it is to establish credit early.

But what is a credit score?

Before I really get into any more details, I want to explain first what a credit score actually is for those that don’t really understand. If you do, feel free to keep moving along.

Unless you’re independently wealthy already, chances are you aren’t going to be able to afford to just go out and pay cash to purchase all the things you want in life. You’re going to have to borrow some money for something like a car or a house, maybe it’s just a new refrigerator or something. That could mean you have to get a loan or use a credit card.

Banks won’t just give you the money for what you want and then have faith that you’ll give it back. Their decision on whether or not to actually borrow you money is going to be based on how likely it is that you will be able to responsibly take on the debt and eventually pay back the money you borrowed (plus interest).

The better your credit score, the more likely you will be to be able to borrow money.

What Makes Up a Credit Score?

Your score is based on five several different factors. Each of these factors makes up a certain percentage of your score.  So some are more important than others.  They are:

  1. Credit Utilization (30%)-the amount of credit you’re using as a percentage of your overall limit.  If you have an overall credit limit of $1,000 and you’ve used $500, your utilization is 50%.  Banks like to see it below 30%.
  2. Payment History (35%)-a record of your bill payments including all those you’ve made on time as well as those you’ve missed.
  3. Credit Age (15%)-the average age of all your open credit accounts.  The longer your credit age history, the better impact it has on your overall score.
  4. Mix of Accounts (10%)-a summary of all the different types of accounts you have.  Banks like to see that you can manage revolving accounts like credit cards as well as installment accounts like a car loan.
  5. Credit Inquiries (10%)-how many times a hard check on your credit has been requested by a business or businesses in the last year.

While all of these factors are important and there is a lot that can be discussed about each one, today I want to discuss credit age.  This is simply because I think there are far too many young people out there that don’t understand the importance of establishing credit.  They only come to understand once their bad credit has started to have a negative impact on their finances and their aspirations.

Steve’s Story

To explain what I mean, I want to share a story about a guy named Steve.

So Steve is in his early 20s and up to this point in his life, his relationship with money has gone something like this.

Steve has bills to pay. Steve finds a job. He goes to work, he gets a paycheck, cashes the paycheck, and spends all the cash in the next two weeks on bills and whatever else he wants to buy. When the money is gone, it’s gone.

Until he gets paid two weeks later, that is.

Wash, rinse, repeat.

Steve has a basic checking account, no savings has never bought anything using any means other than cash. Steve didn’t go to college and has never had a loan of any kind.

No big deal, right? That means Steve has never had any debt.

Yay! Go Steve.

Or not.

So Steve is in a relationship. He and his girlfriend make the big decision to buy a house. They know nothing about the process of buying a house because they’ve never bought a house. They look at houses, find one they like, make an offer, it gets accepted and then Steve and his girlfriend go to finance the house.

This is where the story takes a dark twist.

Because Steve up to this point literally has no credit history, he gets denied financing from the bank. They have no idea how responsible Steve is with his money because he has no credit score.

While everyone must start somewhere in order to establish credit, buying a house is not one of those places. It’s not for beginners.

Steve learned this the hard way because he wants to buy a house with his girlfriend but he can’t. The bank won’t give him the money because they don’t know if Steve will consistently make his mortgage payments.

Steve got lucky, though. His girlfriend was smart enough to start fixing her finances a couple years earlier by paying off all her bad debt, getting her first secured credit card, making consistent payments and building credit from there. Luckily, Steve’s girlfriend has established good enough credit to finance the house with the help of a family member that co-signed for her.

They still get the house but Steve can not be on the mortgage because the bank told him he’s too much of a financial risk.  Even though Steve makes a decent income, they won’t borrow him the money because there is no indication of how likely it is he will make his mortgage payments on time.

In the end, Steve still moves into the house. But if things go south with his girlfriend, he’s getting kicked to the curb because, even though he pays half the mortgage, there’s nothing on paper that says the house belongs to him.

An Important Lesson for Young Adults

As can be seen from Steve’s story, your financial goals (buying a house in this case) aren’t going to happen if you haven’t built any credit for yourself.

It’s absolutely imperative for you to start this process early in adulthood.

While credit age not the most important factor when calculating a credit score, having no credit at all can mean the difference between getting approved or rejected for financing on even a used car in your 20s.

Having accounts that you opened early in adulthood that you can keep open and in good standing for a long period of time, such as a low limit credit card, will have a positive impact on your overall credit age as you get older.

The better your credit score when you’re older, the better financing options you will have. Many times this comes in the form of lower interest rates on large loans.  Lower interest rates mean thousands of dollars in savings that can go straight towards investments.

So how can I establish credit if I don’t have any?

Like I said, everybody starts somewhere. If you’ve never had any personal loans, student loans or anything of the sort, there are a couple ways you can go about establishing credit. Here are just a few of them:

  1. Have your name added to someone’s credit card account

    If you know someone that has really good credit and pays of their card balances every month, you can start to build a little credit by having your name attached to their account.

    When my little sister was 20, she was in this position. The only things she had to her name were a bunch of collections accounts from her past, some of which she knew nothing about. I had zero balances on all my credit cards at the time and suggested to her that she let me add her name to my accounts.

    Because she had no credit history and she was added to accounts that were in really good standing, her score instantly shot up almost 100 points.

  2. Get yourself a secured credit card

    Credit card companies will almost never give you anything other than a secured card if you have no credit history. For many people with no credit history, this is their only option when it comes to getting a credit card.

    I know someone that was hesitant to put the money down for a secured card because they didn’t really understand how the whole process worked. But after being convinced that a secured card was the best next step he could take to keep building up his credit, he got the card. Since then, he has managed to responsibly use the secured card for an extended period of time, resulting in the credit card company upgrading him to an unsecured card.  Everybody has to start somewhere.

  3. Get a co-signer on a small loan

    If you are thinking about financing a purchase, it’s not entirely impossible to get a loan with no credit history. It is sometimes possible to do it with the help of a co-signer. A co-signer is someone with good, well-established credit that the bank believes could take on your debt if you can’t pay. This means that if you miss payments on the loan, your co-signer is also liable for the debt and it will negatively affect the cosigner’s credit score in addition to your own.

What if we don’t plan on incurring any debt soon?

This is a good question.  Why is it so important that we establish credit early if we don’t plan on financing a house or a car anytime soon?

The first thing mentioned earlier was that it’s beneficial to your score to have long-standing accounts.

But the second reason is that it’s a good practice. Managing our money, being financially savvy and knowing how our money habits can affect our credit score is not knowledge we are born with.

We need to learn these skills and the best way to do so is with practice and repetition. We’re all going to make mistakes with our money.  But with time and experiences that allow us to learn from our mistakes, we come to develop good money habits.

You shouldn’t wait to start building up your credit six months or a year before you plan to take on a huge amount of debt.

Focusing on building good credit now will save you thousands of dollars down the road.

If you don’t even know what your score is or if you even have one, a good place to find out is Credit Sesame.

Don’t wait any longer… it’s time for you to take responsibility for your financial future!

How have others established credit? How has your credit age affected you financially?

Be on the lookout for the next installment of the Credit 101 for Millennials Series!

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2 thoughts to “Credit 101 for Millennials: The Importance of Establishing Credit Early”

  1. Thanks for sharing such a great read. We can’t emphasize enough on the importance of building credit on time. Unfortunately, there are too many that simply don’t realize the huge impact it has on our lives.
    We definitely need more people to inform our youth AND elder about this.

  2. Not respecting my credit was a mistake I did early in my career. Apart from my regular job I also had a side gig that contributed strongly to my income stream. The problem was that I did not include that in my taxation even though it was attached to my bank. Problem? I could not use it as an income source while applying for a home mortgage loan. I only could show my regular job’s salary and that meant limits in how much I could borrow.

    I learned it the hard way but yeah, respect your credit score the moment you enter college.

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