In a recent survey by LendEDU, millennials show a lack of understanding about credit scores. Most were more likely to pick common misconceptions about credit scores rather than show an understanding of how things work. Clearly, many millennials need to brush up on basic financial education.
Don’t use more credit
Millennials understand that credit cards can help you build a good credit history. The problem is that they don’t understand how that credit is calculated. One of the glaring mistakes that millennials held onto is the idea that by using more credit will improve your credit score. More than 40 percent believe increasing credit use helps the credit score, and 36 percent believe that maxing out credit but paying on time will help. Higher credit card use is seen as a risk to lenders and will lower your credit score. Only 17 percent answered correctly — that decreasing credit use will improve your credit score.
Credit score calculations elude some millennials. Although the majority had a relatively better grasp on the idea, the fact that a portion answered this way shows that there are still a lot of misconceptions regarding credit scores. 8 percent of those surveyed believe that race plays a factor in determining credit scores, another 8 percent believe that gender plays a role and a third 8 percent believe that registered political affiliation determines credit scores. If that wasn’t enough, 25 percent didn’t know that credit scores have three digits.
Even though millennials don’t know how credit scores work, they are staying away from credit cards. The percentage of Americans under the age of 35 who hold credit card debt is the lowest since 1989, according to The New York Times. Many of the fears stem from having lived through the 2008 financial crisis.
How are credit scores calculated?
Credit scores are based on five factors: payment history, amount of debt, length of credit history, types of accounts and recent activity.
Payment history is the most heavily weighted factor at 35 percent, so missing payments will impact your credit score. The higher amount of on-time payments will help your score, and every missed payment will hurt your credit score. How often you miss payments, how long after a due date you pay your bills, and how recently its been since you’ve missed payments also are taken into account.
The next-highest factor is the amount of debt, which makes up 30 percent of your credit score. The types of accounts you have and how much credit you owe versus how much you have available play a large role in calculating this number. Having high balances and maxed-out credit cards will lower your score. New loans with no payment history can lower scores, but loans that are close to being paid increase the score because it shows a history of paying back loans.
Length of credit history factors in at 15 percent — the longer that you have had credit, the higher your credit score will be. The types of accounts you have comprise 10 percent of your score; having a mix of credits cards, home loans, installment loans, retail cards, etc. can improve a credit score. Recent activity is the final factor at 10 percent Applying for or opening new accounts can lower credit scores, but maintaining the same credit cards or loans and paying on time can help improve your credit score.
Takeaway: Millennials need to stay away from credit myths
Millennials spread and believe many misconceptions about credit. Some of these myths can cause harm to credit scores and hurt millennials’ financial success. Using a credit card more often can be seen as a risk, not a benefit, when calculating your credit score. It’s more important to pay credit cards on time. The factor that most heavily determines your credit score is your history of payments. Brushing up on the various factors that calculate credit scores, and staying away from misconceptions that hurt credit scores, can help people stay away from the pitfalls that lead to bad credit scores.
Have something to add to this story? Comment below or join the discussion on Facebook.
Header image: Adobe Stock