What you should consider before applying for a new loan when interest rates are rising
According to a new study by TransUnion, many US consumers are just beginning their credit journey. The current survey of the Schufa “Strengthening Credit Inclusion: A Deeper Perspective for Consumers Who Borrow” shows that in the United States, 5.8 million consumers opened their first credit product and became New-to-Credit (NTC) during 2021. And another 3 million became NTC by the first half of 2022.
While 46% of US consumers cited convenience as the primary reason for opening their first traditional credit product, access to credit products goes beyond covering occasional expenses.
“A credit card is a unique product,” says Charlie Wise, co-author of the study and head of global research at TransUnion. “It offers many benefits, but the primary two are a means of settling transactions and the second is a means of borrowing.”
What is a “credit new customer” and what types of credit products do they use?
New credit customers are consumers who are just entering the credit market for the first time. According to the study, Gen Z made up the largest portion of this NTC group (59%), followed by Millennials (21%), Gen X (12%) and Baby Boomers (7%).
For US consumers, the most common first product across the board was a credit card and the primary reason for opening an account: new spending emerging. The second and third most popular initial products were auto loans and private label cards.
Some consumers may choose to use their credit card for various transactions that they might make during their day-to-day spending, but others use it as a starting point for building a long and positive credit history that future lenders will accept.
While these products are easily accessible, the purchasing power these products offer to new consumers tends to be on the lower end.
“Unless you have a track record, it’s very unlikely that the card issuer will give you a $10,000 line,” says Wise. “Most of the time, you get $500 to $1,000. As an unsecured leash, they give you a relatively short leash that you can rely on until you’ve proven your track record.”
Why access to credit is crucial
Many reported that other credit products, particularly mortgages, were considered inaccessible. Funding major financial milestones like buying a first home is still touted as a key factor in long-term wealth accumulation. Without access to credit products, consumers who are not particularly affluent could face an additional obstacle to achieving these goals.
“It’s not surprising that mortgage lenders are typically conservative; it’s highly unusual for them to provide a mortgage to someone who has no credit history at all,” says Wise. “Many consumers, especially new borrowers, are realizing that going home-owning and being able to get a mortgage to buy a home means you have to build that track record, you have to start somewhere.”
A positive credit history and high credit score are often rewarded by lenders in the form of higher credit limits and loan amounts, more favorable repayment terms, and lower interest rates. However, building this credit profile takes time and requires that you manage your credit responsibly by making payments on time, avoiding applying for new credit too often in a short period of time, and keeping your credit utilization low.
“Over time, as consumers get older, their limitations will increase. In some cases, utilization increases, but in some cases they can push their limits enough that they can keep their utilization rates relatively low,” says Wise. “The rule of thumb is that consumers should keep occupancy below 30%. This has a positive impact on their creditworthiness. And if they can keep it even lower, even better.”
What you should know before opening a new loan product
Before considering a new credit product, it’s important to evaluate your current financial situation and whether accessing new credit will help or hurt you in the long run.
- Examine your budget. Before you apply for a new loan or credit card, it’s important to understand how the payments associated with this product will affect your budget and how much you can comfortably afford each month. “Saying, ‘Hey, I’ll spend money now and take care of it later,’ isn’t a good strategy,” says Wise. As an NTC, you might be tempted to spend more than you can afford at the end of the month and find yourself spiraling into unmanageable debt. Having a plan before you spend money can ensure you don’t find yourself in a bind.
- Read the fine print on the loan product you are considering. TransUnion’s study found that high interest rates were a top reason for declining credit card offers among consumers across all regions. While this may be a reason to decline an initial offer, it’s important to note that your credit card’s APR is subject to change and NTC customers should keep an eye on their interest rates when opening a product for the first time and as long as they have that product keep. A recent Bankrate survey found that 43% of US adults who have credit cards don’t know all of their interest rates. Take the time to understand the terms and conditions of the product you are considering. Check the interest rate shown to you, possible fees and charges, and repayment periods. Knowing these key stats can help you determine if that particular product is the best fit for you and your budget.
- Think long term. If you are new to the lending market and about to take out a new loan or credit card, consider that loans, if managed responsibly, can help you gain access to a range of wealth-building opportunities. “We’re not advocating for people to open a credit card and start putting significant amounts of money on it,” says Wise. “But once you’ve built that track record, once you’ve established that longevity [it] will serve you really well to help you when you are ready to buy a house [and] to take out low-interest loans. For example consumers [who] Many people who want to start small businesses use personal loans and this ability to borrow is really beneficial.”
