When shopping for a home loan, one of the critical ingredients for success is a relatively good credit score. Borrowers taking out a mortgage in the second quarter of 2021 had an average credit score of 786, according to the Federal Reserve.
Not only do lenders require borrowers to meet specific credit score requirements, but a good credit score can also help you lock in the best rates. If you are planning to buy a home in the near future, safeguarding your credit score is necessary.
Looming economic storm clouds make protecting your credit even more important. The odds of the U.S. economy tipping into recession during the next 12 months climbed to 60% this month from 50% in September, according to a Bloomberg survey of economists.
If buying a home is on your radar, protecting your credit score is a must. Although it’s a bit more challenging during a recession, staying flexible and prioritizing your credit score offers a way to safeguard this financial tool.
Let’s explore some of the strategies you can employ to protect your credit during a recession.
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Increase Your Savings
When the economic storm rolls in, it’s impossible to know what’s in store.
“We do not know how long the economic downturn will be here for or how high inflation will go.” said Cameron Burskey, managing director of retirement security at Cornerstone Financial Services.
“Seeing that the cost of goods has risen drastically, and we don’t know when it will stop, means you will need more money to live day-to-day,” he said. “Needing more money to live day-to-day means less money in your checking account.”
The reality is that everyone faces some level of uncertainty around their job security. If you lost your job, or if your dollars aren’t stretching as far, it can be challenging to keep up with your debt payments. And unfortunately, falling behind on your debt payments can lead to negative impacts on your credit score.
Burskey recommends you “double your short-term savings account to make sure you have a nice cushion to fall back on.”
If you can make the necessary changes to your budget, start building up an emergency fund for whatever a recession may throw your way. Many experts recommend saving between three to six months’ worth of expenses in your emergency fund. But the amount you are able to save will vary based on your situation.
Pay Down Debt
Heading into a recession with extensive amounts of debt is a risk. If you lose your income, you could get stuck in a tough situation unless you have an extensive emergency fund.
“If you can pay off bills now, you'll have more leeway in your budget later because you won't have to worry about making that payment,” said Levon L. Galstyan, a CPA associated with Oak View Law Group.
Galstyan recommends: “Credit card debt and other debt with higher interest rates should be prioritized first, followed by auto loans, mortgage payments, and personal loans.”
As you pay down debt, the benefits are two-fold. First, you’ll have fewer obligations later if your income streams dry up. Second, you’ll lower your credit card utilization ratio, which can give your credit score a boost.
Make On-Time Payments
Even if you make progress repaying your debt, you might still have several debt payments due each month. Although a recession can make on-time payments a challenge, it’s critical to make this a priority.
In the best-case scenario, your income streams will give you the ability to make on-time payments every month. But if you lose your job and run out of emergency savings, it might not be possible to make ends meet.
For those in a tough situation, make sure to communicate with your creditors.
“If you're in a situation where you've lost work and are falling behind, contact your creditors. They may be able to defer some payments until you're back on your feet,” said Andrew Rosen, CFP and president of Diversified LLC.
Making sure that your baseline credit payments are made on time will protect your credit score while the economy takes us on a rollercoaster ride.
Take a Look at Your Spending
Since a recession brings uncertainty to everyone’s finances, it’s helpful to keep an eye on your budget.
“If you don't budget, now may be the time to work on budgeting and keeping track of your expenditures to ensure that you're not spending more than necessary,” said Rosen.
When you keep tabs on your spending, you can create a reasonable budget for your situation. For example, you might find room to cut out discretionary purchases for a few months to beef up your emergency fund. Or you’ll know what’s relatively easy to cut out of your spending if you run into a cash crunch.
Consider Another Income Stream
One of the biggest threats during a tough economic time is losing your job. Without money coming in, it can be challenging to stay afloat and protect your credit score. Building a second stream of income offers some level of credit score protection during a recession.
Even if you lose your job, the second source of income can help you stay on top of your credit payments. With Zapier reporting that one in three Americans have a side hustle, you’d be in good company if you decide to take this leap.
Monitor Your Credit Score
Regardless of the economic climate, it’s helpful to monitor your credit score. When you regularly check in on your credit report, you can ensure that everything is accurate. If you spot an error, you can have it corrected before it makes too big of an impact.
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