With record high inflation and rising interest rates, fears of a recession continue to plague the U.S. economy. Recessions cause economic distress for businesses and consumers alike, but they can also threaten your credit scores.
You don’t have to wait for an official recession to occur before you start working to protect your credit. Take the steps now to help prepare for a recession.
How Does a Recession Negatively Affect My Credit Score?
Your credit score won’t automatically drop if a recession occurs. But recessions can create many situations that can affect your finances and, by extension, your credit scores.
Because recessions typically cause consumers to spend less, businesses tend to respond by shedding jobs and laying off workers. If you’re a business owner with decreased income or a laid-off employee, you can have trouble paying your bills on time or effectively managing your debt. This can have a direct impact on your credit.
If you can’t pay your bills on time, late payments can land on your credit report and negatively impact your credit score after 30 days past due. The longer you go without paying, the greater the damage can be to your credit score. Delinquent accounts and accounts in collections can remain on your credit report for up to seven years.
In addition, you may rely on credit cards for loans to get you through lean financial times during a recession. However, if you take on too much debt and it becomes unmanageable, your credit scores can suffer. And racking up a high credit utilization ratio on your credit cards can lower your score as well.
How to Prepare Your Credit for a Recession
1. Pay Your Bills on Time
Keeping up with your bills is the most important thing you can do for your credit, as payment history is the biggest contributing factor to your credit score. If you pay all your bills on time, you continue to build a positive payment history.
But a single late payment can have a significant impact on your credit. So, if you’re behind on any payments, make a point to get yourself current now. The longer you let your bills go unpaid, the more damage they can do to your credit.
If you have trouble remembering to pay your bills, implement a system to keep track of your payments. Consider setting up calendar reminders for due dates or automatic bill payments from your account.
2. Create a Budget
If you don’t already have a budget, making one can help you stay organized and put your money toward the most critical priorities. You can sign up for a budgeting app or use an Excel spreadsheet to get started. Then, plug in your monthly income and expenses to gain insight into your cash flow.
Even if you’re in good financial shape now, having a budget can prove valuable if something changes due to a recession. It can be easier to make spending adjustments and reallocate funds on the fly if you already have a budget.
3. Pay Off Debt
Eliminating debt now can help when a recession hits. You might reduce your monthly bills, free up money in your budget for other things or increase your borrowing power should you find yourself in financial hot water. This can help you continue to pay your bills on time and avoid taking on too much debt.
Paying off credit card debt can also reduce your credit utilization ratio. Generally, low credit utilization is beneficial for your credit scores.
4. Dispute Inaccuracies on Your Credit Report
Check your credit reports to verify that the information they contain is accurate. The last thing you want during a recession is inaccurate information negatively impacting your credit score and affecting your credit applications, employment prospects or even where you can rent a home.
Suppose you see inaccurate information like accounts you don’t recognize. In that case, if you have late payments you didn’t miss or applications for credit you never submitted, you want to have them removed from your report. These items can be the result of a simple inaccuracy or a sign that you’re a victim of identity theft.
Consider signing up for a credit monitoring service like MyScoreIQ, which can provide you with regular copies of your credit report and alert you when new information is added. That way, you can stay on top of inaccurate information and quickly dispute it.
5. Build Up an Emergency Savings Fund
An emergency savings fund is a buffer between your finances and unexpected events like job losses, vehicle repairs, medical bills and more. It’s recommended to save up enough to cover your expenses for three to six months. But, even if that seems impossible, saving something is better than nothing.
Savings can help you get through economic hardship and unanticipated expenses. It can also help you avoid going into debt since you won’t have to rely as heavily on credit cards or loans to get you through lean times.
Put a line item in your budget for monthly savings to build up an emergency fund over time, giving you some peace of mind and quick access to cash when needed.
6. Get the Credit You Want Now
If you’re considering applying for a loan or credit card in the near future, get started now. Lenders and credit card companies become more selective about who they work with and how much credit they grant during a recession.
Of course, you shouldn’t just apply for a loan or credit card you don’t need. And your budget, high-interest rates and other factors should also play into the decision. But if you have to access credit, anyway, doing so before a recession makes it easier to qualify for what you need.
Protecting Your Credit Before a Recession
You should always practice good credit habits, whether you think a recession is coming. But paying your bills on time, avoiding high credit card balances and actively monitoring your credit can help keep your credit score in good shape ahead of an economic downturn.