By Allan Halcrow | American Express Credit Intel Freelance Contributor
6 Min Read | February 14, 2020 in Credit Score
Economic downshifts can lead to people struggling with reduced income while, at the same time, creditors may tighten their lending rules in order to lower their business risk.
During such times, protecting your credit rating can become particularly challenging.
People who monitor their credit, are proactive about managing it, and ask for help if they need it may be more likely to maintain their scores when times get tough.
Even when the economy is strong, maintaining your credit score in good standing usually takes a certain amount of awareness, vigilance, and financial discipline. But when the economy stumbles, some of the factors that shape your score may be beyond your control. People’s incomes may drop, and it can take longer to repay what they’ve already borrowed – and in more challenging situations, some may let their credit card balances rise to help with their essential expenses. At the same time, lenders typically reassess their risk and may tighten lending standards.
But even during economic shifts, there are many ways you can be proactive about protecting your credit rating. I’ll explore some tips often offered by personal finance specialists for how to maintain your credit score.
Credit experts have long encouraged Americans to monitor their credit reports and credit scores, but during economic shifts you may want to be extra vigilant. And the major credit reporting agencies seem to agree credit monitoring is important: during the last major economic downshift, all three offered free weekly credit reports for a year instead of once a year, as required by law.1 Knowing the score can help you set reasonable credit score goals, such as maintaining a good or excellent score, or improving from a fair score to a good one – for more, see “Credit Score Ranges: What is an Excellent, Good, or Poor Credit Score?” Monitoring can also help you catch errors that may hurt your credit score. To correct errors, see “How to Dispute Your Credit Report at All 3 Bureaus.”
And, if your score does get dinged, some experts recommend that you add a consumer statement to your report explaining your situation.2 The Fair Credit Reporting Act allows 100 words for such comments, and the reporting agencies encourage people to take advantage.
Your payment history is the largest component of your credit score, so late payments hurt. And they typically hurt more the longer payments are delinquent. People who are one payment behind would be smart to catch up before becoming 60 or 90 days past due. A credit score simulator can help you see approximately how late payments – or catching up on your payments – will affect your credit score, and let you explore the impact of a variety of other credit scenarios.
If your payments are current, the next-biggest influence on your credit score is the total amount of your debt compared to your available credit limits – aka your credit utilization ratio. Experts say to use no more than 30% of your total limit at any time to maintain your credit in good standing. So it’s wise to pay down your debt to that level. An added benefit: By doing so, you’ll free up cash to use for basic expenses instead of interest charges.
If maintaining your credit score is the goal, it’s usually better to use available cash to pay bills than to turn to your credit cards. This is why experts recommend that we save enough in an emergency fund to cover our expenses for about six months without incurring debt. Many people hesitate to tap into their emergency savings, but unexpected economic shifts are one of the reasons why you saved it in the first place. This can also help you protect your credit score, because any credit card debt usually translates into a higher credit utilization ratio – which can hurt your score.
Keeping your utilization low helps your credit score, but experts say you’re better off charging small amounts to a credit card each month and paying your full balance because not using credit cards at all can backfire. FICO, which provides most credit score models, suggests that having a 0% credit utilization ratio might hurt your credit score.3 That’s because creditors are interested in how responsibly you manage your available credit, and you have to use credit to show how you manage it. In addition, some creditors may close inactive accounts to reduce their credit risk in a downturn.
When the economy hits a rough patch, financial institutions may extend offers to help people who find themselves in difficulty – especially if their credit reports show they’ve been responsible borrowers, historically. For example, my credit union recently offered to waive two monthly credit card payments without reporting missed payments to the credit bureaus and without charging interest during that time.
Other credit card companies might help by lowering your monthly payment, waiving late payment fees, or offering other accommodations. But in general, you have to ask them for help. How much you might save and for how long can vary. Creditors may consider your current financial situation, as well as your relationship with them.
If you do seek some sort of relief, experts urge you to do so before your payment is late. If you reach an agreement, it pays to understand what implications it may have for your credit score, which may differ from one downturn to another. For example, the CARES Act of 2020 includes a provision requiring creditors to report accounts as current if the person had reached an agreement with their creditor.4 For more, read “Navigating a Changing Personal Debt Landscape.”
Protecting your credit score in a downshifting economy may require managing your expense budget more carefully. You can start by listing all the funds you have available, including unemployment, cash in your emergency fund, or earned vacation hours that can be cashed in. Then track all of your expenses. Once you have the data, you can identify non-critical expenses you may want to cut.
Such cuts can free up funds for the truly essential expenses, help you pay down existing debt, or build up your reserves – all of which can help to keep your credit score high. For help developing a realistic monthly budget, read “How to Start Saving Money by Spending More Mindfully.”
Vigilance and discipline are usually critical to earning and keeping a good credit score, but they’re even more important in an economic downturn. If you figure out where you stand financially, are proactive about curbing expenses and managing your payments, and ask for help when you need it, it’s more likely you can protect your credit score – or even improve it.
1 “Equifax, Experian and TransUnion Announce Free Weekly Credit Reports to Help Americans in Response to COVID-19,” Equifax, Experian and TransUnion
3 “What is Amounts Owed?,” FICO
4 “The CARES Act Works for All Americans,” US Department of the Treasury