Does Unemployment Affect Your Credit Score?

Are you one of the millions of people who are still dealing with the fallout from the deadly coronavirus pandemic that swept not just the nation but the world?

More than 50 million Americans filed for unemployment in 2020 alone. It's going to take time for us to rebuild and get back on solid financial footing. Part of that rebuilding process is ensuring we're staying informed.

If you're wondering how unemployment may affect your credit score, here are the answers you're looking for!

Direct Impact

Question: Does unemployment directly affect my credit score?

Answer: No.

The good news for those who suddenly found themselves out of work is that unemployment does not directly affect your credit rating. When you're looking to take out a loan or finance a major purchase, your chosen lender will typically take a look at your FICO score. That score is based on a few factors, none of which are your employment status.

So, what is your FICO credit score based on? According to myFICO.com:

• 35% payment history
• 30% amounts owed
• 15% length of credit history
• 10% new credit
• 10% credit mix

Since your income and employment status aren't included in the data that is pulled for your credit rating, unemployment doesn't directly impact your score.

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Indirect Impact

Your employment status is not considered when determining your credit score. That's great. But does it mean that unemployment can't affect your credit rating at all? Unfortunately, no. Being unemployed can indirectly affect your credit score.

Losing your source of income can have far-reaching consequences, especially if you're unable to find another steady source of income in a timely manner. With so many Americans out of work, the competition in the job market is fierce, which means it may take longer to secure employment than you anticipated.

The longer you're out of work, the harder it becomes to keep up with bills, especially if you don't have a budget that you're sticking to. On that note, here are three ways a lengthy unemployment period could affect your credit score.

1. Increased Credit Card Balances

Many were forced to rely on credit cards to get by during their period of unemployment, and that could lead to increased credit card balances. If you were one of the millions who turned to credit cards, and you're not able to keep up with payments, that results in a higher amount owed. If you recall, amounts owed make up a significant portion of your credit score; 30%.

That means that if you keep increasing those balances, then yes, your credit score could take quite a big hit. If you're forced to pay just the minimum amount across multiple accounts because funds are tight, that alone could increase the balances you owe, thanks to the hefty interest rates that most credit cards come with.

Using a credit card for daily living expenses may be a necessity at the moment. Just be sure that you're earmarking at least a portion of the incoming money you do have for those bills. Staying on top of your payments could significantly protect your credit rating.

2. Falling Behind on Payments

What accounts for an even higher percentage of your credit score than amounts owed? Your payment history. Making up a whopping 35%, if you fall behind on payments, your credit score will take a hit.

That being said, there is good news when it comes to your payment history. Typically, if you're just a month or two late and you've had a strong payment history up until this point, your score shouldn't see a significant drop.

Of course, you want to catch up as soon as possible. The faster you do, the smaller the chance your credit score is impacted. It may be wise to consider borrowing money from a friend or family member so that you don't fall too far behind.

It can be difficult not to get bogged down in the day-to-day. While borrowing money may not be something you're eager to do, think about the best move you can make now to protect your financial health in the long run.

3. Being Forced to Open New Accounts

Are you one of the many who was trying to keep credit card balances below a certain amount, so you signed up for a few more cards? While spreading your debt around can seem like a great idea, it makes your credit score take a hit. Those hard inquiries on your report can lower your score, as can opening too many cards in a short amount of time.

Having too many credit cards can also make it difficult to keep track of payment schedules, making it more likely you'll fall behind and rack up high interest fees.

Of course, some of us have no choice. If you do need to open new cards to survive, try to space them out so you're not opening multiple accounts in one week, and be sure you're staying organized with your repayment efforts.

Keep Pushing Forward

So, does being unemployed or even filing for unemployment benefits hurt your credit score? No, not directly. But the trickle-down effect that unemployment has could cause your score to take a hit.

If you're looking to protect your credit score and, thus, your long-term financial health during your stretch of unemployment, do everything you can to stay on top of payments. Refinance your mortgage to a lower interest rate if you're able to, create a budget–and stick to it–and consider borrowing money from a family member if you've already fallen behind.

And remember: This is not a permanent state. Millions of Americans became unemployed through no fault of their own. The important thing is to keep going and remember that this financial rut is not a permanent state. There is light at the end of the tunnel, so keep taking steps forward. In time, you'll be able to rebuild and can move forward with finely-tuned money-management skills that you can utilize in the years to come.