Protect your credit against the unexpected

Unforeseen circumstances can put your finances and credit at risk. Still, the idea that your credit is destined to suffer in an emergency isn’t quite right.

Consider the coronavirus pandemic, for example. While many Americans have struggled financially, the average FICO® score actually increased among US consumers between April 2019 and April 2021.

The fact that FICO® scores have increased nationally despite the pandemic should be encouraging news. This indicates (at least to some extent) that there are effective steps you can take to protect your credit in unforeseen circumstances.

How Emergencies Can Affect Your Credit Score

Whether you’re facing job loss, illness, natural disaster, or one of the many financial challenges that can arise during a global pandemic, emergencies can strain your budget. And when situations like the ones described above arise, your credit score could be in jeopardy.

Unforeseen expenses

From car repairs to surprise medical bills, unexpected expenses are a reality that every household can face from time to time. Nevertheless, a recent Bankrate survey found that less than half of adults in the United States have the savings to pay for a large, unexpected expense.

There are ways to manage emergency expenses without jeopardizing your credit health, even when you don’t have the savings to cover them. However, if you are not careful, unexpected expenses could lead to credit problems such as:

An unexpected expense won’t hurt your credit, but how you react to a financial emergency can factor into your FICO® scores.

Changes in interest rates

The interest rates you pay on your credit obligations do not influence your FICO® scores. But a rise in interest rates on a credit card or other revolving account could have a significant impact on your household budget.

Changes in interest rates can also have an indirect effect on your credit. Below are some examples.

A higher interest rate could:

  • Increase your credit utilization rate on a credit card. If you don’t pay your credit card balance in full each month, you’ll usually incur interest charges. The card issuer adds these charges to your existing balance, which increases the amount of debt you owe. A higher balance can trigger an increase in your credit utilization ratio, a scenario that could negatively impact your FICO® scores.
  • Increase your monthly payments. Higher interest rates can result in larger balances and monthly payments on your credit obligations. If your budget is tight, the added pressure might be too much to handle. When an increase in interest rates results in late payments or missed payments, these actions can negatively impact your FICO® scores.

How to protect your credit in an emergency

On a positive note, it is possible to protect your credit against the unexpected. Tom Quinn, vice president of scores at FICO, says building healthy credit to withstand unpredictable circumstances isn’t much different from the actions you need to take to build a healthy FICO® score, in general.

Prepare in advance

The first key to protecting your credit in an emergency is to prepare in advance.

“The time to try to restore your credit is not at the dawn of some unforeseeable circumstance,” says Quinn. Instead, you want to make an effort to cultivate a good FICO® score ahead of time.

There are many ways to try to improve your credit score if you are unhappy with its current state. Still, it’s important to note that a history of on-time payments is one of the most important factors affecting your FICO® scores.

“Demonstrate this behavior [paying bills on time] all the time generates a lot of positives for the score,” says Quinn. “And that’s something you would want to strive for…to be able to withstand unpredictable circumstances and have a good FICO® score.”

Create an emergency fund

Another way to protect your credit against the unexpected is to build a solid emergency fund. A financial safety net could help you avoid collateral credit issues (like late payments) that might arise in an emergency.

“It’s important to be able to cover bills and other obligations you may have in the event of loss of income, job loss, or major expenses like a major car or home repair,” says Quinn.

For this reason, many financial experts recommend having at least six months of monthly expenses in an emergency savings account.

If six months seems daunting, remember that it’s okay to start small. You can set an initial goal – maybe $1,000 – and build from there. Any amount of savings can put you in a better position to deal with the unexpected.

Work with your lender on a payment accommodation plan

Sometimes spending cuts and savings aren’t enough to help you meet your emergency payments. If you find yourself in a situation with more bills than money, it’s worth talking to your lender to see if special payment arrangements are available.

“You can always contact your lender to let them know about your stressful situation,” Quinn says. “Many lenders would like to keep you as a client and work with you to try to temporarily relieve the pain of this situation you find yourself in.”

If your lender accepts a payment accommodation due to a natural disaster or pandemic (such as a loan forbearance or deferred payment plan), the fact that your account is enrolled in such a plan should not matter. affect your credit score.

Consider financing

Strategically opening new credit accounts also has the potential to protect your credit in an emergency. Here are two scenarios to demonstrate why applying for new credit can help you prepare for the unexpected.

  • An extra credit card could provide an easy-to-access financial cushion when you need it. Just be sure to use the credit card wisely (and all your other accounts) so it doesn’t lead to unnecessary debt and overspending. Paying off your entire statement balance each month is an important habit to develop.
  • Consolidating debt with a low rate consolidation loan or balance transfer could benefit you in many ways. If you can use a new account to save money and pay off your debt, debt consolidation could help put you in a better financial position before the next unexpected expense arises.

The bottom line

Trying to maintain healthy credit may not be on your priority list when dealing with a stressful financial emergency. Still, since credit can have a significant impact on your overall financial health, it’s worth trying to protect it.

Quinn recommends staying on top of your credit reports and scores, especially during uncertain times.

“It’s something that doesn’t take a lot of time, and it’s a good process to go through to make sure you know how your information is being reported and how lenders are interpreting it,” Quinn says.

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