How to protect your credit during a recession
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There’s a good reason the possibility of a recession sends chills down personal finance experts’ backs. A decline in economic activity over several business cycles can wreak havoc on millions of people’s lives. Financially strapped employers may decide to let large numbers of workers go. The stock market can dip, causing a devaluation of investments just when investors need the money to live on when they retire. According to a July 2022 Bankrate poll, 52 percent of economists believe a recession will begin within the next 12 to 18 months.
Keeping your credit in shape will help you prepare for problems associated with a recession. Here are some strategies you can employ before and during an economic downturn.
Know your current credit scores
High credit scores will keep low-cost financial opportunities open, which will be important if you want to borrow money during a recession.
Check your credit scores now to see what they are. The FICO Score is most commonly used, and it has a scale ranging from 300 to 850, with higher numbers indicating less credit risk. Good scores begin at 670, but the closer you can get them to the top – and then keep them there – the better.
“Credit is king,” says Ramona Ortega, CEO of My Money My Future. “We use it to leverage and build assets. If your scores are low, you will pay more because the interest rate will be higher. Entering a recession with high scores will give you more access to cheaper capital when you need it. That can be a credit card, a loan or a mortgage refinance.”
Revise your budget
Now is the time to review all of your expenses, then reduce costs where you can. According to Ortega, many people spend on things they don’t care about and can easily eliminate. To safeguard your credit against a recession, you will want to free up cash for increased debt repayment and more substantial savings.
“If you’ve been spending like you don’t have a budget, stop and create one,” says Ortega. “You have to know your numbers. Look at your spending in detail so you can find out if you are going over what your net income allows.”
Your credit card statements are a great place to start. You can use your card statements as a budgeting tool. Identify which expenses you can let go of, such as a gym membership you never seem to make use of, streaming services you don’t need and excessive dining out.
Once done, take the steps necessary to scale back spending, and add that money to savings or to expedite debt deletion.
Secure your employment
For consumers, one of the scariest byproducts of a recession is the possibility of mass layoffs. The July 28, 2022, Forbes Advisor-Ipsos Consumer Confidence Biweekly Tracker found more than 40 percent of those polled believe they or someone they know is at risk of losing their job in the next six months.
Without a regular income, meeting your expenses and financial obligations can be extremely difficult, especially if you have insufficient savings to fall back on. That can put your credit at risk. You may miss payments or start to lean on credit products to bridge the gap, then acquire a large amount of debt.
For the moment, though, the news is favorable. The August 2022 Bureau of Labor Statistics jobs report announced that the U.S. is still experiencing a labor shortage and there are currently 11.24 million available positions. Therefore if you’re not getting paid what you think you’re worth, this may be the ideal time to search for a new position.
“There are jobs out there, if you’re looking for a better one,” says Ortega. “But if you want to stay with your current company, be that employee who is invaluable. Have a conversation with your boss and express why you want to stay and how you want to move up. Ask how you can get there.”
Build an emergency fund
There isn’t a better time than now to start or build an emergency fund. According to Shindy Chen, author of The Credit Cleanup Book and Credit Score Hacks, rising interest rates that work against debtors work in favor of savers. Interest rates are rising on money market and interest-bearing savings accounts, as well as your credit cards. Aggressively adding to a savings account that you can draw from in case of emergency is wise, since you can actually see a return on the money in deposit accounts.
“Try to accrue four to six months of living expenses in case something goes wrong and you lose a primary source of income,” says Chen. “There’s nothing like financial peace of mind. Knowing you’ve got a little cushion can help you overcome any short-term uncertainty or financial anxiety.”
The cash you set aside in a deposit account can prevent you from falling behind on payments or borrowing too much, factors that would negatively impact your credit rating. Just withdraw what you need and replace the funds as soon as possible.
Reduce consumer debt
One of the most powerful actions you can take to recession-proof your credit is to reduce consumer debt. High credit card balances result in large monthly payments and expensive interest fees. This is the last thing you want during a recession because it makes your personal financial situation unstable. Most credit cards have variable interest rates, which may increase during a recession. If that happens, the debt you’re carrying will become even more expensive than it is now.
In addition to increasing your payments with refined budgeting, you may also consider selling unnecessary assets and sending the proceeds to the creditors with the highest interest rates. Or increase your income with a second part-time job, or gig-work you do on the side, adding those earnings to the amount you send your creditors. The less you owe the better.
Consolidate credit to lower rate products
For the consumer debt you can’t delete, consider consolidation. If you can move the balance to products that offer a lower rate – or can score a deal where you pay no interest at all for a fixed period of time – you can save a lot of money. If your credit scores are high now, don’t delay. “When you have a good credit, you have way more options to consolidate,” says Ortega.
Balance transfer credit cards can be particularly beneficial. For maximum protection against an uncertain economy, try to find a good balance transfer card with a particularly long 0 percent APR intro offer. For example, U.S. Bank Visa® Platinum Card offers 0% intro APR on purchases and balance transfers for 18 billing cycles. After that the variable APR of 18.74% – 28.74% applies.
Imagine you have $10,000 worth of credit card debt, with a 23 percent APR. If you were to send a fixed $650 payment it would take 19 months and cost over $1,963 in interest to pay off. But shift it to a card with 0 percent APR (plus a 3 percent fee) and you send equal payments of $543, you would be out of debt in the same time frame with no interest added. The monthly payment would be $197 less, and you could add it to your emergency savings account!
Another option is a consolidation loan, where you can combine multiple unsecured debts at a lower average fixed interest rate. These loans topically have terms between one and 10 years, so if you don’t have the means to pay off your debt within a credit card’s balance transfer time frame limitation, it’s worth checking out.
Be aware that debt consolidation with a new credit product can cause your credit score to drop initially, but it can improve your credit over the long term since you’ll be paying off your outstanding debts faster.
Maintain or increase your credit scores
There are a few key rules for maintaining and building high credit scores, says Chen. Most critical is to pay the accounts that appear on your credit report by the due date, no matter what.
Use your credit cards for transactions, but either pay the bill in full or keep the balance to below 15 to 25 percent of your credit limit. This is a conservative ratio compared to the standard advice of having at least 70 percent of the limit available, but during a recession it makes sense. You’re guaranteed to pay less for the debt you carry over.
Combined, these two factors — payment history and credit utilization — comprise 65 percent of your FICO Score, so if you stick to the rules you’ll come out ahead.
Keep up good credit habits in any economy
The strategies you employ to protect your credit against a recession will help you in any economy. The recession may not happen, but you have no control over it if it does. What you can control is the way you earn, save, spend and borrow. Make the best financial decisions you can, now and into the unpredictable future.