Job Loss & Credit Checks

Protecting your credit score while you have a steady income is one thing but trying to stay afloat after a job loss is another thing entirely. One of the most challenging aspects of managing credit is when life deals you a tough blow – be it a job loss or a divorce or an unexpected medical issue. Suddenly, the work you have done to make on-time bill payments and stay up-to-date on all of your loans is in jeopardy.

No one is immune to this, from the blue-collar factory worker to the white-collar executive. Job losses are a reality for millions, whether through corporate layoffs, recessions, or simply resigning from a job that was not a fit for your goals and interests.

Whether you resign voluntarily, are laid off, or fired from a job, you need to make a swift plan to keep your credit in check. It is important to note that the job loss itself won’t affect your score; in other words, your credit isn’t automatically dinged because you were terminated by your employer. However, the possibility of your credit being in jeopardy because of the financial implications of the job loss are quite serious.

If you have no savings to rely on or other ways to continue to pay your bills on time, you may very well find yourself missing payments and by extension damaging your credit score. And then you step into what can become a vicious cycle: job loss leading to financial strain lowers your credit score, and then potential employers who CHECK credit scores see you in an unfavorable light, possibly costing you your NEXT job. It’s a challenging predicament and one you want to avoid at all costs.

Planning for the unexpected, be it a job loss or a medical emergency, is one of the most important things you can do for your overall financial health and credit history. No one wants to think of a time they will be unemployed or ill, but ignoring these realities is akin to burying your head in the sand. It is better to be prepared in advance, which will not only ensure financial stability but will also ease the stress during periods of life that already take a heavy emotional toll.

We’ll take a look at some things you can do to prepare for these scenarios and how you can protect your credit when they happen.

Credit History & Job Loss

Again, it is worth repeating that the job loss is not an immediate “ding” to your credit score. Lenders won’t automatically reject you based on the fact that you have lost a job. It’s hard to imagine anyone would ever be able to secure credit if that were the case!

Instead, your credit score is comprised of five key components:

  • Length of credit history
  • Credit utilization
  • Credit mix
  • New credit
  • Payment history

As you begin to understand how these components play into the credit score system, you will have a better idea of how your own score was generated and how the financial fallout after a job loss might play into your score.

Length of Credit History

Your credit history (also sometimes referred to as payment history) is a record of your debts and payment history as well as public records including bankruptcies, judgments, and liens.

Your credit history is everything you have done in the past with regards to using credit. Credit history includes the amount of credit you have used, your payment habits, and if creditors have had to resort to using collections agencies in an attempt to get you to repay your debts.

When considering whether or not to lend you money, the primary goal of a lender is to determine what the odds are that you will not repay debt. Your credit history is the best indicator they have of your overall credit risk. The assumption made by lenders is that you will continue to behave in the future as you have in the past—that your financial behavior will remain largely the same (if not gradually grow worse) over time.

Without any credit history, a lender has no real basis for the decision, making you a significant risk when it comes to granting you a loan. FICO scores, which are the most commonly used credit scores, break down the length of credit history into three additional components:

  • The length of time the accounts have been open
  • The length of time specific account types have been open
  • The length of time since those accounts have been used

The scoring formula is set up to evaluate your oldest and newest accounts as well as the average age of all your combined accounts.

In a scenario where you stopped using credit accounts more than a decade ago, you may find that you don’t generate a credit score or credit history, no matter how responsible you were with your past accounts. This is why you should carefully consider your score before closing accounts, even if your instinct is that it is the “right” thing to do.

If you intend to seek loans in the future, keeping some of the fully paid accounts open may benefit you in the long run! So after being laid off or terminated, don’t rush to close accounts out of fear, when this could backfire on you. Instead, cut back on spending and just make sure you are paying down all the accounts.

Credit Utilization

Another component of your credit history is your credit utilization. This is defined by a ratio, and the calculation is fairly simple: take the amount of revolving credit you are currently using and divide that number by the total amount of revolving credit available to you.

In other words, if you have a $100 debt against a total credit limit of $1,000, your credit utilization ratio comes out to 10%.

It is important to understand this component of your credit history refers to revolving credit only: think of this as credit without a specific end date. Home and auto loans would not apply in this category, as you have agreed to pay home and auto loans in a specified time period.

A credit card, on the other hand, falls into “revolving credit” as you can carry a balance from month to month without a specific end date, paying some or all of what you owe and continuing to borrow against your limit as long as you have not maxed out the card.

While the credit scoring system looks at an overall ratio, the individual card ratio is also important. In other words, you may have a scenario where you have $20,000 available in credit between three different credit cards.

On one card you owe $500 against a limit of $5,000 (10%), on another card you may owe $250 against a limit of $5,000 (5%), but on the third card, you owe $8,000 against a limit of $10,000. On that third credit card, you have a high utilization ratio of 80%, which will outweigh the “good” ratios on the other cards.

The ideal scenario as far as your credit utilization ratio goes is staying in the range of 30% or less. In other words, you want to ensure that you keep your usage limited to roughly one-third of your maximum credit available.

Keeping the utilization ratio low after a job loss is especially tricky. You may need to charge more than usual without a steady paycheck to cover your normal expenses, such as a home mortgage, utilities, car loans, and more. If you have to move to a utilization ratio greater than 30%, try to get this back down as quickly as possible.

Credit Mix

The general rule of thumb when it comes to this component of your credit history is to maintain a diverse mix of credit accounts….as long as you pay them on time! Lenders want to see that you have successfully managed a variety of accounts, which may include credit cards, home or auto loans, and student loans.

When considering credit mix, you also have to factor in the rate of opening new accounts: opening too many in a short span of time may very well work against you. Therefore, you want to think strategically about the timing of new accounts as well as the overall mix of them.

Opening a variety of accounts just to increase your “diversity” could actually backfire on you if they are opened quickly in a short timeframe: this could send a signal to lenders that you were in a period of financial distress. Bear in mind that the “credit mix” component is only 10% of your overall rating, so it’s not advised to act too aggressively in this area.

Immediately after a job loss is not necessarily the best time to open new accounts, so consider managing this component of your score once you are back on your feet and gainfully employed.

New Credit

New credit is another component that makes up only about 10% of your overall score, and this is another area where you need to think strategically about credit and loan decisions. New credit can easily work against you, but it can also work in your favor when coupled with the credit utilization ratio.

Here’s how this works: part of your credit score is assessed by looking specifically at loans you’ve applied for in the most recent 6-12 month period. On the one hand, if you have applied for numerous recent loans (i.e., taken on more debt), you may pose a greater risk to lenders. This can have an overall negative impact on your credit score.

However, if you have applied for a new credit card that improves your credit utilization ratio, this can ultimately be a win for you regarding credit score. A $9,000 debt on a card with a $10,000 limit is a major red flag, but if you transfer that $9,000 debt to a card with a $20,000 limit, you have instantly improved your credit utilization ratio.

Opening new cards and taking on new debt “just for the sake of the score” is never a good idea. You should only make strategic choices based on your individual finances and needs, and until you have a new job, you should probably avoid opening new accounts and racking up additional debt.

Payment History

When it comes to credit scores, nothing is more important than payment history. Paying your bills on time is the best thing you can do to maintain a good score: there is no getting around this!

The payment history component of the credit score makes up about 35% of the overall score. This is a “make or break” component. Your track record of on-time payments speaks volumes to lenders; this gives them some assurance about your future financial behavior.

To put the severity of late loan payments into context, consider this: if you are one month late paying a credit card bill or loan, your score may drop more than 100 points. That is extremely significant in that it can move you from a “good” rating to a “poor” rating immediately. Bear in mind that co-signers of loans and shared credit card account holders are also attached to the other party’s financial behavior, for better or worse.

Paying your bills on time after a job loss may seem impossible, but you should make every effort to stay on track. Reach out to anyone you owe – be it credit card companies or medical offices – and explain your situation and see if you can agree on a new payment plan until you get back on your feet. If you have to utilize savings accounts to stay on track with bill payment, do that and then make a plan to replenish the accounts as soon as you are employed again.

Call For Credit Assessment

For help with credit score repair, after a job loss, a divorce, a medical emergency, or any other circumstance, reach out to the trusted professionals at Lexington Law for guidance.

Call 1-855-255-0139
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