For decades, young adults have gotten themselves in trouble by maxing out their credit cards and digging themselves into a huge debt hole. Yet while millennials have developed what many believe is a healthy aversion to credit cards, their choice to give up on them entirely rather than using them prudently and responsibly will create its own problems.
A recent study from Fair Isaac Corporation (NYSE:FICO)‘s Fair Isaac Corporation (NYSE:FICO) took a look at the demographics of credit card use lately. What they found is that outstanding credit card debt among 18- to 29-year-olds dropped from just over $3,000 in late 2007 to a bit over $2,000 last October. That move comes as part of a broader reduction in overall indebtedness, with drops in outstanding mortgage, auto, and most other debt more than offsetting a substantial rise in student-loan debt. Even more surprisingly, the proportion of young adults going without credit cards entirely has risen to nearly one in six, almost double the level from late 2005.
Aren’t millennials being smart about credit cards?
Many consumer-finance experts are applauding the decisions of young adults to avoid credit cards, noting the effectiveness of regulations like the CARD Act that limited access to credit cards for those under 21. Moreover, using alternatives like electronic payments and debit cards can help people avoid spending beyond their means, as such payment methods are usually tied to accounts that need to have money present for transactions to get approved.
The fact that more young people have chosen not to carry balances and pay high interest rates for unnecessary loans is an unqualifiedly positive result. Yet not having credit cards at all is one step too far, as it prevents young adults from enjoying many benefits that credit cards have over alternatives:
- Credit cards offer built-in protection from fraudulent charges, with a dispute mechanism allowing you to question charges on your account. The law limits your liability for credit card losses at $50 even if you don’t make a report until well after those charges are made. By contrast, the Electronic Fund Transfer Act sets a much higher liability limit of $500 if you don’t report a loss promptly after you find out about it, and you could be responsible for all the losses if you wait more than 60 days after a statement is sent. That’s at least one reason why major banks
- Prudent credit card use is the best way to establish a credit history that can help you improve your chances of qualifying for a mortgage, obtaining a car loan, or even seemingly unrelated things like getting a job.
- Certain transactions are a major hassle without a credit card. For car rentals, for instance, companies will often debit your checking account immediately for a deposit, yet a credit card authorization is sufficient without an immediate charge for credit card users.
- Many credit cards offer much more lucrative rewards like cash back or airline miles than you’ll find with debit cards.
- The threat of future debit-card fees still exists. Even though Bank of America Corp (NYSE:BAC), Wells Fargo & Co (NYSE:WFC), and Citigroup Inc (NYSE:C) all backed down from test programs or plans to start imposing fees for debit cards a couple years ago, there’s nothing stopping them from potentially doing so in the future.
Many millennials answer these objections by arguing that they don’t want to add to their debt levels. Yet there’s no requirement that you misuse credit cards by carrying a balance. One strategy you can follow is to treat credit cards exactly as you would debit cards, entering every purchase in your checkbook and taking the money mentally out of your account. Then, all you have to do is make your payment in full every month to reconcile your account balance and get all the benefits of credit cards without any of the hassles.
Give credit a try
Not carrying a credit card balance is smart, but not having a credit card at all is a big mistake. If millennials are prudent enough to live without credit cards entirely, they should be able to avoid temptation once they have one — while reaping the potential benefits that can come in handy from time to time.
The article The Huge Mistake Millennials Are Making With Their Money originally appeared on Fool.com is written by Dan Caplinger.
Fool contributor Dan Caplinger owns warrants on Wells Fargo and (NYSE:WFC) Bank of America. You can follow him on Twitter: @DanCaplinger. The Motley Fool recommends Bank of America and Wells Fargo and owns shares of Bank of America, Citigroup, and Wells Fargo.
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