How to protect your credit during a recession

There’s a good reason the prospect of a recession sends chills down the backs of personal finance experts. A decline in economic activity over several business cycles can wreak havoc on the lives of millions of people. Employers in financial trouble may decide to let go of large numbers of workers. The stock market can fall, causing investments to decline just when investors need the money to live on in retirement. According to a Bankrate survey from July 2022, 52 percent of economists believe a recession will start within the next 12 to 18 months.

Keeping your credit in shape will help you prepare for the 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 financing 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 the most widely used and has a scale from 300 to 850, with higher numbers indicating less credit risk. Good scores start at 670, but the closer you 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’ll pay more because the interest rate will be higher. Going into 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.”

Check your budget

Now is the time to review all of your spending, and then cut 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’ll want to free up cash to increase your debt payment and achieve 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 expenses in detail so you know if you are going over your net income.”

Your credit card statements are a great place to start. You can use your card statements as a budgeting tool. Identify what expenses you can set aside, like a gym membership you never seem to use, streaming services you don’t need, and excessive dining out.

Once this is done, take the necessary steps to reduce spending and add that money to savings or to speed up debt elimination.

secure your job

For consumers, one of the scariest byproducts of a recession is the possibility of massive layoffs. On July 28, 2022, the Forbes Advisor-Ipsos Consumer Confidence Biweekly Tracker found that more than 40 percent of respondents 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 don’t have enough savings to fall back on. That can put your credit at risk. You can stop making payments or start relying on credit products to bridge the gap, and then take on a large amount of debt.

For the moment, however, the news is favorable. The August 2022 Bureau of Labor Statistics jobs report announced that the US is still experiencing labor shortages and there are currently 11.24 million jobs available. So if you’re not being paid what you think you’re worth, this may be the ideal time to look 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 his boss and tell her why he wants to stay and how he wants to move up. Ask how he can get there.

Create an emergency fund

There’s no 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 borrowers work in favor of savers. Interest rates are rising on money market and interest-bearing savings accounts, as well as on your credit cards. It’s wise to aggressively add to a savings account that you can draw money from in an emergency, as you can actually see a return on the money in deposit accounts.

“Try to accumulate four to six months of living expenses in case something goes wrong and you lose a main source of income,” says Chen. “There is nothing like financial peace of mind. Knowing that you have a small 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, both of which could negatively affect your credit score. Simply 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 protect your credit against the recession is to reduce consumer debt. High credit card balances result in large monthly payments and expensive interest rates. 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 can increase during a recession. If that happens, the debt you owe will be even more expensive than it is now.

In addition to increasing your payments with a refined budget, you can also consider selling unneeded assets and sending the proceeds to creditors with the highest interest rates. Or boost your income with a second part-time job, or an extra job you do on the side, by adding those earnings to the amount you send to your creditors. The less you owe, the better.

Consolidate credit to lower rate products

For consumer debt you can’t eliminate, consider consolidation. If you can move your balance to products that offer a lower rate, or you can get an offer where you pay no interest 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 good credit, you have many 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 introductory 0 percent APR offer. For example, US Bank’s Platinum Visa® Card offers 20 billing cycles with no finance charges added to transferred balances, with a 3 percent transfer fee.

Imagine you have $10,000 worth of credit card debt, with an APR of 23 percent. If you were to send a fixed payment of $650, it would take 19 months and cost more than $1,963 in interest to pay off. But switch it to a card with 0 percent APR (plus a 3 percent fee) and send equal payments of $543, and you’d be debt-free in the same period of time with no added interest. Your 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 typically 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 limit, it’s worth a look.

Keep in mind that debt consolidation with a new credit product may lower your credit score initially, but it can improve your credit in the long run by paying down your outstanding debts faster.

Maintain or increase your credit scores

There are a few key rules to maintaining and building high credit scores, says Chen. The most important thing is to pay the bills that appear on your credit report before the due date, no matter what.

Use your credit cards for transactions, but pay the bill in full or keep the balance 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 are guaranteed to pay less for the debt you transfer.

Combined, these two factors—payment history and credit utilization—comprise 65 percent of your FICO Score, so if you play by the rules, you’ll come out on top.

Maintain good credit habits in any economy

The strategies you use 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 how you earn, save, spend and borrow. Make the best financial decisions you can, now and into the unpredictable future.

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