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If you're worried a recession could impact your credit score, your fear isn't completely unfounded. While credit scores are not directly affected by recessions, if your financial situation changes due to a downturn in the economy, your scores could change as well.
Because credit scores are based on how you manage your debt, financial conditions that cause you to fall behind on payments or rely too heavily on new debt can have an impact. Whether or not your income is affected during a recession, it's still important to take action to protect your credit score in uncertain economic periods. Here are six ways to protect your credit during a recession.
1. Understand How a Recession Could Impact Your Credit
A credit score is an indicator of how you manage your financial obligations. And when things in your financial life change—for better or for worse—your credit score could fluctuate.
Though recessions impact many aspects of the economy, one of the greatest risks consumers face is reduced income or unemployment. Losing your income could mean not being able to pay your monthly expenses—including your debt payments. Because payment history is the most important factor in calculating credit scores, if you fall behind on debt payments, your credit will likely suffer.
A loss of income may also force you to take on more debt, which can hurt credit scores. Running up credit card balances to pay for expenses can increase your credit utilization ratio, which is the percentage of available credit you're using. Credit utilization is the second most important aspect of your credit scores.
It's best to keep your utilization ratio for each of your credit cards, and overall, under 30% to avoid hurting your credit scores—but the lower your utilization, the better.
2. Monitor Your Credit
Regularly monitoring your credit is crucial to knowing if your scores drop and why. By reviewing your credit reports and credit scores often, you'll see how your credit is responding to changes in your financial life, if at all. This can help you understand what actions you may need to take, adjusting your finances where possible to move your credit to a better place.
Checking your credit can also alert you to any inaccurate information in your reports. Mistakes, though rare, can happen when information is reported to the credit bureaus, and inaccuracies in your credit report could be pulling your credit scores down. If you find something in your report that you believe shouldn't be there, you can file a dispute with the credit bureau that maintains the report where the information appears. Keep in mind that accurate information cannot be removed from your credit reports.
To keep a closer eye on your credit reports and scores, consider using Experian's free credit monitoring tool for regular insight and alerts that tell you when something in your credit report has changed.
3. Pay Off Existing Debt
If you're fearful a recession could take a toll on your credit, try to pay down your existing debt sooner rather than later. Here's how:
- Cut back spending. Cutting back on clothes purchases, making more meals at home instead of ordering takeout or canceling subscriptions you no longer use, for instance, can put extra cash in your pocket. Take any extra money you save and apply it toward your monthly debt balances.
- Use the debt avalanche method. Make minimum payments on all your credit cards except the one with the highest interest rate—then put as much as your budget will allow toward paying off that highest-interest card. Once it is paid off, use the same strategy with the card that has the next-highest interest rate and so on until all your cards are paid off.
- Use the debt snowball method. You use the same general approach here as with the debt avalanche method, except you put the most each month toward the card with the lowest balance. While you'll typically save more money using the debt avalanche approach, if quick wins and seeing accounts paid off is important to you, this could be a good strategy.
- Consider a side hustle. Not only could a side hustle help you pay off debt faster, but having multiple streams of income can help you feel more secure in times of economic uncertainty. You could find a traditional part-time job or explore gig work such as driving for a ride-hailing service or pet sitting. You could also consider freelancing in a field you already have experience in.
- Get a balance transfer credit card. Managed the right way, a balance transfer credit card can help you save money and pay off debt faster. Balance transfer cards often offer no-interest introductory periods during which you can transfer balances from other cards and pay them off without paying interest. Keep in mind that most balance transfer cards typically require good to excellent credit for approval and charge a 3% to 5% fee on transfers.
4. Build an Emergency Fund
If you lose part or all of your income during a recession, you'll want to have a backup fund to tide you over until you find a new job. Emergency funds are dedicated savings accounts used to cover unexpected expenses. They can protect your credit by providing needed cash to pay your bills or help you avoid maxing out your credit cards.
Experts recommend having at least three to six months' worth of living expenses in an emergency fund, but if you can save more, even better.
You can start to build an emergency fund by setting aside however much you can afford each month. Even if you can only afford to save $100 per month, that's better than not having a fund at all. To ensure you save every month, set up automatic deposits so money is automatically transferred from your checking account to your emergency fund account.
Not sure where to keep your emergency fund? You could open a savings account at the bank where you have a checking account, look for a high-yield savings account, or consider a money market account, certificate of deposit and other options.
5. Contact Your Lenders
Because payment history is the most important aspect of your credit score, you should do everything you can to make sure you don't miss any debt payments. If you know you won't be able to afford your monthly bill, reach out to your creditors as early as possible to see if they have any relief options available.
During an economic crisis, some lenders may offer options specifically designed for people struggling to pay bills, such as payment deferment, a lower interest rate, an adjusted repayment schedule or other help. This relief could bridge the gap until you're able to resume normal repayment. Taking advantage of these options first is your best bet when you know you can't pay on time and want to avoid getting a derogatory mark for missing a payment.
6. Stick to a Budget
Though it's always a good idea to maintain a responsible budget, this strategy is increasingly important during an economic downturn. Budgets help you allocate your income, portioning your funds in a way to help you save and spend efficiently.
When a recession hits, having a budget in place will help you quickly adjust your spending should your income be reduced. Use your budget to figure out which expenditures you can live without and which you absolutely need. Revising your budget to cut out non-essential purchases and limit your spending to essentials can help you get through a difficult financial period.
The Bottom Line
Even if your income isn't affected during a recession, taking steps to pay off debt, build a healthy emergency fund and pay off debt can help you boost your financial resilience and ensure that you're living within your means. By checking these boxes when you aren't financially overextended, you'll be in better shape should the economy begin to suffer.