How to Protect Your Credit Score During Financial Hardships
Financial hardships can strike unexpectedly, whether due to job loss, a health crisis, or a natural disaster like the COVID-19 pandemic. In these moments, managing your credit score can be a challenge, but it’s essential to maintain it. A good credit score affects your ability to borrow money, rent an apartment, or even secure certain jobs. The good news is that you can take steps to protect your credit score even when facing financial difficulties. This article outlines key strategies to help you safeguard your credit during hard times.
1. Communicate Early and Clearly with Your Lenders
The first and most crucial step is to reach out to your lenders as soon as possible. Whether it’s your credit card company, mortgage lender, or loan servicer, letting them know about your situation is key. Many lenders offer hardship programs that can temporarily reduce or suspend your payments without damaging your credit score. Some of the options you can discuss include:
- Forbearance: Temporarily pausing or reducing your payments.
- Deferred Payments: Postponing payments to a later date without penalties.
- Reduced Interest Rates: Lowering interest rates to make payments more manageable.
Being upfront with your creditors shows responsibility and keeps you in good standing, avoiding surprises that could harm your credit later on.
Real Example: During the COVID-19 pandemic, major lenders like Chase and Bank of America implemented emergency forbearance programs, allowing customers to defer mortgage and credit card payments. Contacting your lender can open doors to similar options during other financial crises.
2. Understand Forbearance and Deferred Payment Plans
When facing financial stress, forbearance and deferred payment plans are some of the most common ways to protect your credit score. However, it’s crucial to understand how these programs work.
- Forbearance allows you to pause or reduce payments for a set period. This can prevent missed payments from being reported to the credit bureaus, saving your credit score from immediate harm.
- Deferred Payment Plans push payments to a later date, usually without accruing interest or penalties during the deferral period. Your credit score is protected as long as you meet the terms of the agreement.
Although these options can help you avoid immediate damage, it’s important to confirm how the lender will report your account to the credit bureaus during forbearance or deferment. Some lenders may continue reporting your balance, which could affect your credit utilization rate, a key component of your credit score. Keeping your credit utilization below 30% is critical to maintaining a healthy score.
3. How Credit Bureaus Handle Hardship Cases
Credit bureaus understand that financial hardships can happen to anyone, and they have systems in place to help. When you enter forbearance or a deferred payment plan, lenders can report your situation to the bureaus using special hardship codes. These codes indicate that your financial difficulty is due to external circumstances like a natural disaster or health crisis.
In cases like the COVID-19 pandemic, these hardship codes were vital in ensuring that missed payments did not negatively impact credit scores. The VantageScore 3.0 and 4.0 models, for example, are designed to account for hardship codes, preventing a score from dropping due to missed payments when these codes are applied.
Tip: Always ask your lender to apply a disaster or hardship code if you qualify. This ensures that your credit history reflects the reality of your financial situation and that credit bureaus handle it appropriately.
4. Key Steps to Take Before Missing Payments
If you anticipate financial hardship, it’s important to act before you miss a payment. Here’s a checklist of steps to follow:
- Evaluate Your Budget: Take a close look at your expenses and identify areas where you can cut back. This will help you prioritize essential payments, such as housing, utilities, and loan obligations.
- Contact Your Lenders: As mentioned, this is your first line of defense. Even if you’re not yet behind on payments, reaching out early can lead to temporary solutions that prevent damage to your credit score.
- Explore Government and Nonprofit Assistance: During large-scale disasters, such as hurricanes or pandemics, government programs or nonprofit organizations often offer financial assistance. For example, during COVID-19, the CARES Act provided mortgage forbearance options for federally backed loans.
- Set Up Payment Reminders: If you’re managing multiple accounts, setting up reminders or automatic payments can help you avoid missing payments accidentally. Even a single missed payment can lead to a dip in your credit score.
- Monitor Your Credit: Regularly checking your credit report ensures that you’re aware of any changes. You can get a free credit report annually from each of the three major bureaus—Equifax, Experian, and TransUnion—through AnnualCreditReport.com.
5. Long-Term Credit Management Tips
Beyond these immediate steps, it’s important to adopt long-term strategies to protect and improve your credit score over time:
- Build an Emergency Fund: While it may be difficult to save during financial hardship, building an emergency fund should be a top priority when your financial situation improves. This fund can prevent you from relying on credit during future crises.
- Keep Credit Accounts Open: Even if you’re not using a credit card, keeping the account open and in good standing contributes positively to your credit history length and overall credit utilization.
- Work with a Financial Advisor: If managing your finances feels overwhelming, consider seeking advice from a certified financial planner or credit counselor. They can help you create a strategy to protect your credit and improve your overall financial health.
Conclusion
Protecting your credit score during financial hardship requires early action, clear communication with lenders, and a strong understanding of available options like forbearance and deferred payment plans. By following the strategies outlined above, you can minimize the impact of financial difficulties on your credit score and ensure you’re in a better position to recover when circumstances improve.
Remember, financial hardship is often temporary, but the steps you take to protect your credit can have lasting benefits.
