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Gen Z Is Poised to Spend More on Debt Than Others. It Could Derail Retirement.

Jade Canney didn’t expect to move back into her parents’ home after renting her own apartment for about a year, but the 22-year-old felt that she had no choice after “drowning” in debt that dragged down her credit score.

Ms. Canney, a sheet metal worker in Springfield, Mass., is paying down roughly $6,500 in outstanding credit card balances, along with several thousand dollars’ worth of medical bills, student loans and other debt, most of it accumulated when she was laid off and out of work for more than six months last year.

As a construction apprentice in a unionized trade, Ms. Canney said her income had been good when she worked full time, but the seasonality and project-based nature of her job meant that her earnings could be inconsistent. “There’s a lot of weeks when I have nothing left after I pay my bills,” she said. “The more you make, it’s like the more you’re drowning. It’s never enough.”

Personal finance experts say Ms. Canney is not alone. Members of Generation Z are struggling to keep up their credit scores because of a combination of higher borrowing costs, slowing wage growth, student loans and other debts. The upshot is an economic climate in which young adults are — and will be — paying an increasing amount of their disposable income servicing their debts, more than Americans in other age groups do. It’s a reality that experts worry could derail their intentions to build wealth, buy homes and save money for retirement.

Evidence suggests that more young adults are struggling financially today than in the immediate aftermath of the pandemic. Diana Rascon, a senior certified consumer credit counselor at Money Management International, a nonprofit credit counseling organization, said that more young adults, as well as parents reaching out on their children’s behalf, had sought help from her organization to manage growing amounts of debt.

Ms. Rascon said many young adults don’t understand the fundamentals of borrowing, including interest rates and the way high borrowing costs can cause a debt balance to balloon. A credit cardholder’s interest rate, or A.P.R., for instance, reflects the cost of borrowing money as an annualized percentage. “The shocking thing for me as a counselor is they don’t know what an A.P.R., or annual percentage rate, is. They don’t know how to budget. They don’t know how to track their expenses,” she said. “Some of them don’t even know what a credit report is or what that means.”

Stable yet shaky

The social and economic upheaval of the pandemic appeared to have a silver lining for some members of Generation Z. According to a study from the Transamerica Center for Retirement Studies, 29 percent of survey respondents in Generation Z — generally defined as people born between 1997 and 2012 — said their financial circumstances were better today than before the pandemic, compared with 21 percent across all age cohorts.

Many young adults have taken advantage of the tight labor market, according to Transamerica. Three in 10 hold two or more jobs, which appears to have given some members of this age bracket a substantial jump on building a nest egg: Two-thirds of young adults are saving for retirement in a 401(k) or similar plan, contributing 20 percent of their pay at the median — a rate double that of working Americans overall.

But there are indications that these gains are being eroded, particularly as wage increases slow and the student loan payment pause comes to an end. Experts worry about the high rate at which young adults are tapping into their retirement savings. “It’s very concerning to me — four in 10 Generation Z workers have taken a loan, early withdrawal or hardship withdrawal,” said Catherine Collinson, the chief executive and president of the Transamerica Institute and Transamerica Center for Retirement Studies. “It’s counterproductive if they’re dipping into their savings so early in their adult lives,” she added, because it triggers taxes and penalties as well as robs these account owners of the opportunity to have their funds grow through compounding.

Young adults face mounting credit challenges

The Fair Isaac Corporation created the most commonly used credit scoring model in the country. The three-digit FICO score, which has a range from 300 at the low end to 850 at the high end, is a weighted composite of a borrower’s credit risk — that is, the likelihood that they will fail to pay back what they borrow. The scoring model includes five types of data: The most important is payment history, which amounts to more than one-third of the score, followed by the amounts owed, length of credit history, new credit and the mix of different types of credit.

While these conditions aren’t age-specific, Gen Z is at a distinct disadvantage because 15 percent of a credit score is derived from the length of a borrower’s credit history. The average credit score for adults 25 and younger is 679, compared with 714 for all Americans, according to the credit reporting bureau TransUnion. On a scale that ranges from 300 to 850, 679 is high enough to qualify someone for many loan types, including conventional mortgages, but it’s not good enough to get the best interest rates.

Young adults who are Black and Latino face even greater challenges. The Urban Institute, a think tank, found that young adults between ages 21 and 24 who live in communities that are predominantly Black have average credit scores of 597, which sharply limits their opportunities to borrow — and improve those scores.

Margaret Libby, the founder and chief executive of MyPath, a nonprofit promoting economic mobility, said that some common credit-building recommendations for young people, such as being added as an authorized user on a parent’s credit card, were less accessible for young adults of color as well as those in lower-income communities. “It’s an equity issue, it’s a real equity issue in this space,” she said.

For young adults with little credit history, other attributes of their credit score take on outsized importance. “This is one of the categories where what a young consumer can best do in this category is building their credit and building their credit history,” said Ethan Dornhelm, the vice president of scores and predictive analytics at FICO.

Making on-time payments is always the most important part of improving or maintaining a high credit score, followed closely by the amount of debt owed, a measure industry experts call a borrower’s credit utilization ratio: essentially, what percentage of available credit has been used. People who max out their credit cards have a high credit utilization ratio, which can drag down a credit score.

For young borrowers in particular, keeping usage low is important. “It’s important for people to understand what they do have in their control is how much balance they’re putting on those cards,” Mr. Dornhelm said. “If the limit is on the lower side, the lower they can keep their balances on that card, the better.”

Ms. Canney, the sheet metal worker in Massachusetts, suspects that her 630 credit score is being held down by the high balance relative to her credit limits on a trio of cards she’s paying off. “It’s a game. You have to use them, but not too much,” she said. “Once I get my debt paid off more, it should go up to at least a 700,” she said.

While the high inflation of the past two years has led more Americans to rely on credit cards, the policy tools used to combat inflation also have depressed borrowers’ credit scores. The cost to service debt today is sharply higher than it was before the Federal Reserve began raising interest rates in March 2022. The Fed’s benchmark rate, the federal funds rate, influences the amount of interest people pay on their credit cards and other types of loans. Since then, policymakers have raised that rate from zero to a range of between 5.25 percent and 5.5 percent. Borrowers with credit rated “fair” pay an average of nearly 26 percent interest on credit cards, according to the online personal finance platform WalletHub, and interest rates of close to 30 percent aren’t uncommon, according to credit counselors who work with these borrowers.

“The interest rates, certainly on unsecured revolving debt like credit cards, can have an impact on consumers, especially if they are carrying a balance on those credit cards month to month,” Mr. Dornhelm said.

As a result, paying down enough debt to significantly raise a credit score can be a long process.

Mayra Jaramillo spent five years paying down roughly $30,000 in credit card debt through a debt-management plan with Money Management International, the credit counseling organization, improving her credit score in the process. Ms. Jaramillo, 28, works in a residential facility for disadvantaged children in the Chicago area, as does her husband.

Ms. Jaramillo said she didn’t have the advantage of financial education when she was younger. “I grew up learning that you could pay it later,” she said, but didn’t realize how much interest rates of close to 30 percent would make paying off her purchases a challenge.

Her credit score today is 731, Ms. Jaramillo said, an improvement of more than 100 points since she began the debt-management program. “I’ve noticed that your credit score associates with how much trust you can earn with different companies,” she said. “The better your credit score is, the better your chances of getting a card or a loan that’s not high interest.”

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