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When times are good and you've got a steady income, staying on top of your debt and other bills can be a simple task. During a recession, however, you could face a different reality. If a layoff or pay cut reduces your income, you might have trouble paying your bills, which can hurt your credit scores. But it doesn't have to be that way. You can improve your credit score during a recession by practicing good credit habits, reducing expenses and making sure you have a savings fund to draw on in an emergency.
How Can a Recession Affect Credit?
There are many ways a recession can directly or indirectly affect your credit. Losing your job or taking a pay cut might make it difficult to keep up with your bills. If you miss debt payments or pay more than 30 days late, your credit score will suffer.
If your income is reduced, you might start relying on credit cards to pay your basic expenses. As your credit card debt inches up, your credit utilization ratio will rise too. This ratio measures the amount of revolving credit you're currently using compared with the amount of revolving credit available to you. If you begin using more than 30% of your available credit, your credit scores could suffer.
Applying for too many credit cards, loans or other types of credit during a recession could also negatively affect your credit score. For each application you fill out, the lender will perform a hard inquiry on your credit report. Too many hard inquiries in a short time can suggest to lenders that you're having trouble making ends meet.
Recessions can also make it harder to get new credit. During an economic downturn, lenders often set stricter standards for extending credit, which can make it more difficult to get approved for loans or credit cards. Maintaining or even improving your credit score during an economic downturn can help ensure you can access credit when you really need it.
On the positive side, some lenders may be more willing to work with borrowers who are struggling to make payments during hard times. They may offer options such as reducing or deferring payments, which can help you stay current on payments and maintain your credit score. If you think you may have trouble making your payments, contact the creditor as soon as possible to see if they can help—and try not to wait until a due date has passed. Being proactive can help keep your account in good standing—and keep your credit score from falling.
Check Your Credit Score and Report
One of the first things you should do when a recession hits is check your credit score and get a copy of your credit report so you know where you stand and how much work you'll need to do to improve your credit score.
You should check your credit reports from each of the three major credit bureaus—Experian, TransUnion and Equifax—and review them for any inaccuracies. Creditors sometimes make errors when reporting to the credit bureaus. If a creditor mistakenly tells the credit bureau that you made late payments or that your account went to collections, it could hurt your credit score unless you correct the problem. If you see an error, you should file a dispute with that credit bureau to get the information corrected.
Correcting inaccurate negative information can potentially improve your credit score. Check your credit report on a regular basis to stay on top of any inaccuracies so you can report them to the credit bureau before they damage your credit score. You can also set up free credit monitoring to get alerted of any changes to your credit report and credit score, as well as get a free monthly credit report and score from Experian.
Catch Up on Past-Due Payments
Keeping up with your payments is critical to maintaining good credit during a recession. Your payment history is the single most important factor in your credit score, accounting for 35% of your FICO® Score☉ (the most commonly used score). Even one missed payment can have a negative impact on your credit score.
If you're behind on any of your payments, make it a point to catch up as quickly as possible. Once your accounts are current, be sure to stay on top of your payments. If you have trouble remembering when payments are due or you have a lot of credit accounts to keep track of, consider setting up automatic payments for the minimum amount due. This will ensure you never miss a due date.
Consider Adjusting Your Spending Habits and Building a Budget
If you don't have a budget, now is the time to create one. If you already have a budget, now is a good time to review it and make some adjustments to your spending habits. Tightening your belt and reducing unnecessary spending can help you remain financially stable despite a recession.
To create a budget, determine your income; your essential expenses, such as rent or mortgage, food and transportation; and how much you spend on nonessential items, such as eating out or buying new clothes. Tracking your expenses for a few months can help you get a clearer picture of your spending habits and where you can cut back.
During a recession, you should aim to reduce both essential and nonessential spending as much as possible. Keep your spending within your income limits so you don't have to rely on credit cards. If you must use credit cards, charge only as much as you can pay off in full each month. Building up a big credit card balance could make it hard to keep up with your payments, especially if you lose your job or your income is reduced, and will hurt your credit score.
Make Sure You Have an Emergency Fund
A recession can make your job and income uncertain. You may get laid off, have your hours reduced or have to take a pay cut. If you're self-employed, you may lose customers or have clients go out of business. Building an emergency fund can help ensure you can cover any monthly payments if the recession does affect your income.
Ideally, you should begin saving toward your emergency fund before any signs of a recession appear and continue saving throughout the downturn. But even if you don't have an emergency fund, it's never too late to start one.
As a general rule, experts suggest building an emergency fund that can cover three to six months of essential expenses. If your industry is particularly at risk or if you're self-employed, you may want to save even more. If that's not possible, don't give up—just start setting aside what you can afford each month.
Putting your emergency fund in a dedicated account—ideally, one that earns interest—will help reduce the temptation to pull from it on a whim. (Just make sure you can quickly access the money if needed without incurring a penalty.) To make saving money easy, set up an automated transfer from your checking account to your savings account every paycheck. Also put any "extra" money that comes your way, such as bonuses, tax refunds or cash gifts, into your emergency fund.
Are you having trouble squeezing extra money out of your current income? Perhaps you're already feeling a financial crunch from the recession. If your budget has no room to spare, see if you can get a side job or sell unwanted items, such as clothing, electronics or furniture, to generate some cash for your emergency fund.
Maintain a Good Credit Score Despite a Downturn
Yes, a recession can hurt your credit score—but it's also possible to maintain or even improve your credit score during an economic downturn by taking a few simple steps. Developing a budget, reducing your expenses and building up an emergency savings fund will help ensure you have the funds you need to pay your bills so you can maintain a good credit score, no matter what challenges the economy brings.
If you need to improve your credit score, one quick way to do so is to sign up for Experian Boost®ø, a free service that gives you credit for on-time utility and cellphone bill payments. (Normally, this information isn't part of your credit report.) Even in a recession, you'll still need to pay utility and cellphone bills, so why not use them to boost your credit score?