Unemployment and your credit score are tied together in ways you may not have thought of. Even though we are seeing an uptick in employment levels, job loss is still a fact of life for many Americans. The loss of a job can really wreak havoc on your finances and in some ways your credit. In this post we will discuss the affects unemployment can have on your credit.
Your credit report and unemployment
The good news is that unemployment and your credit score do not have a direct relationship. Loss of employment as well as collecting unemployment benefits has no direct impact on your credit score or report. So when it comes to a lender deciding on whether to extend you credit, they rely on your FICO Score. As such, this score does not take into account anything related to your income or job status. This is because neither is listed on your credit report.
Now for the not-so-good news. Unemployment can most definitely have a trickle-down affect which can lead to serious damage to your credit. For this reason, it is important to understand what can hurt your credit and the steps you can take to minimize and prevent any damage.
Here are some ways unemployment can negatively affect your credit score
Do you know the most significant factor affecting your credit? It is your payment history. It accounts for 35% of your FICO Score. So if you start missing payments, your score could take a pretty big hit. If for some reason you wind up being late a couple of times, you credit score shouldn't change much if you have a strong credit history. If a collection agency gets involved or you file for bankruptcy, you can definitely expect a significant hit to your score.
2. Your credit card balances may increase
When it comes to your credit score, your credit utilization ratio accounts for 30%. This is the amount of debt you owe relative to the amount of debt you are currently using. The higher your percentage ratio is, the lower your credit score may be.
Without an income coming in, you may need to use your credit cards to pay for your living expenses. This means your credit utilization would go up and your credit could take a hit. Furthermore, even if you are making minimum payments, you still have interest charges and those are adding to your balance even if you’re not charging anything new.
3. Your savings account may shrink
Your savings account is another area where you may take a hit. Because your savings account is an asset, lenders do take the amount of money you have into account when making lending decisions. As your savings account balance goes down, the more of a risk they will deem you and your chances of receiving a loan with favorable terms also goes down.
4. You may need to open new credit cards
You may really need to lean on credit cards during this time but opening too many too quickly will bring down your score. Even if you don't get approved for one, the inquiry into your credit can hurt your score. If possible, avoid opening new credit to pay for everyday living expenses if you can.
Now let's talk about ways to protect your credit from taking a hit while being unemployed. We should first touch on what preemptive measures you should be taking prior to becoming unemployed. If you don't have an emergency fund in place already, it is high time you get going on one. Financial experts suggest having at least three to six months worth of expenses saved up. Should you lose your job, you have some money to keep you afloat until you find something new. This will greatly help prevent any credit score damage not to mention racking up debt.
If you are currently without a job and you do have credit card payments to make, strive to at least make minimum payments. Even if this means using your unemployment benefits to make payments. This will help you stay current and avoid delinquency on your payments which can negatively affect your credit score. What you want to stay away from is paying less than the minimum or making sporadic payments. Not only will you negatively impact your score, you will be racking up fees and interest.