Do Credit-Shy Millennials Have It Right?

Though credit card abuse is hardy a new trend in the U.S., it's one that seems to be growing increasingly out of control. Earlier this year, outstanding credit card debt reached an all-time high, totaling over $1 trillion.

But even though it might seem as if most Americans are going out and charging up a storm, data tells us that millennials want no part of it. In fact, younger adults are among the least likely to carry credit card debt, and, as such, are doing their part to preserve not just their credit scores, but their hard-earned money.

The percentage of adults under 35 who have credit card debt has fallen to its lowest level since 1989, according to the Federal Reserve. In fact, a 2014 Bankrate survey found that 63% of millennials aged 18 to 29 don't have a credit card. But while it's one thing to avoid racking up costly debt, it's another to shun credit cards completely. And the latter is a move that could backfire for millennials later in life.

Why it pays to have a credit card

Avoiding credit card debt is a smart way to protect your finances and avoid wasting money on interest payments -- a trap countless Americans fall into. That said, credit cards come with certain benefits that cash simply can't mimic, and if you use your card wisely, you'll get access to perks like cash-back rewards and purchase protection.

But here's an even more compelling reason why it's smart to have a credit card: Without one, you might struggle to build credit, and without credit, you'll have less financial flexibility later in life. For example, you need a strong credit score to get approved for a mortgage, and at a reasonably favorable rate. And while there are other ways to boost your score (like making your student loan payments on time), having a credit card can really work to your advantage.

How credit cards help build credit

To understand the role a credit card might play in establishing a solid credit score, you'll need to understand how those scores are calculated. There are five key factors that go into a credit score, each of which carries a specific amount of weight:

  • Payment history (35%), which speaks to your tendency to pay bills on time.
  • Credit utilization ratio (30%), which is the amount of available credit you're using.
  • Length of credit history (15%), which is the number of years you've held your accounts.
  • New credit accounts (10%), which is the number of accounts you apply for close together.
  • Credit mix (10%), which represents the various account types you have.

Of those categories, using a credit card responsibly can help with the first three (which, incidentally, carry the most weight). First, if you make a point never to charge more on a credit card than what you can afford, you'll have no problem paying your bills on time and in full. This will not only help you avoid interest, but boost your payment history.

Furthermore, if you keep your balance at a reasonable level, you'll put your credit utilization ratio in favorable territory. For it to help your score, that number needs to stay at or below 30%. So if you have a card with a $3,000 credit limit but make certain never to charge more than $900 at any point, you'll boost your score or help keep it in good shape.

Finally, the younger you are when you start using a credit card, the longer your credit history will be. And that itself could help your credit score climb.

You need a strong credit score

Now you may be thinking: "Who cares about my credit score? I'll just make sure I never need to borrow money." But while that's a good idea in theory, it's unlikely to work out in practice. Most adults end up needing financing at some point in time or another, whether it's to buy a home, purchase a vehicle, or cover an unplanned expense. And if you don't have decent credit, your options for borrowing will be limited at best.

So if your plan is to avoid opening a credit card for fear of winding up in debt, you should know that there is a better way. Use that card sparingly, and always track your spending on it so your balance doesn't get too high. Better yet, set a monthly spending cap that's well below the limit imposed by your credit card company so that you don't overcharge, and don't mess up your utilization ratio. The fact that so many millennials are avoiding credit card debt is no doubt a good thing -- but know that it is possible to have a credit card without getting into trouble.

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