National emergencies spur the credit-debt cycle
The immediate effects of COVID-19 have hit U.S. households hard with layoffs, reduced hours, and business closures.
And with this comes another, under-the-surface issue that many don’t think about right away: Credit scores.
National emergencies like COVID-19 can be disastrous for U.S. credit, creating new consumer debt cycles that are hard to escape.
It’s important to protect your credit as best you can, to land on the other side of this crisis in a safe place.
Credit bureaus and the U.S. government are already creating policies to help consumer credit scores stay afloat.
But there are measures you can take to guard your own credit, too. Here’s what you need to know.
In this article (Skip to...)
- Government credit relief programs
- Banks and regulators loosening rules
- What YOU can do for your credit
- COVID-19 declared a “natural disaster” by creditors
- Current U.S. credit scores (what’s at stake)
- Potential long-term effects on U.S. credit
Record levels of debt put U.S. credit in a shaky position
The coming weeks and months are likely to test virtually every American household.
Treasury Secretary Steven Mnuchin has told US senators that the unemployment rate could soar to 20% — more than five times the February level.
If the Mnuchin prediction is anywhere near correct, we are likely to see credit score declines. How much they will falter is unclear but decline they will.
Why? Because at the very time incomes are falling, debts are at record levels.
According to the Federal Reserve Bank of New York, household debt increased to $14.15 trillion in the fourth quarter of 2019. That’s the 22nd consecutive quarter with an increase.
Combine falling income with massive debt, and credit issues could easily become a reality.
What the government is doing to protect your credit score
As coronavirus-related layoffs and closures mount nationwide, efforts are underway to limit homeowner damages and worries.
- FHA foreclosures & evictions. The President has announced that the Department of Housing and Urban Development (HUD) is now “suspending all foreclosures and evictions until the end of April.” This directive applies to properties financed with FHA-mortgages
- Freddie Mac & Fannie Mae foreclosures and evictions. The Federal Housing Finance Agency (FHFA), the government regulator that oversees Fannie Mae and Freddie Mac, has directed the two companies to suspend foreclosures and evictions for at least 60 days due to the coronavirus national emergency. The foreclosure suspension applies to homeowners with single-family mortgages
- Freddie Mac & Fannie Mae forbearance. Fannie Mae and Freddie Mac can “provide payment forbearance to borrowers impacted by the coronavirus,” according to FHFA. This lets borrowers suspend their mortgage payments up to 12 months
- States and cities are stepping in. As an example, in Seattle, the city government has decided that it will not shut off water and electricity for nonpayment. Instead, individuals and companies can set up deferred payment plans
And while these groups work to find repayment solutions for consumer debt, other agencies are working to make sure those modified payment plans won’t negatively affect U.S. credit scores.
Banks and regulators are loosening credit reporting rules
Over the weekend, bank regulators — including the Federal Reserve, the FDIC, the National Credit Union Administration (NCUA), the Office of the Comptroller of the Currency (OCC), the Consumer Financial Protection Bureau (CFPB), and state banking authorities — laid down the law to banks.
Their message? Now is not the time to mess with consumer credit reports.
“With regard to loans not otherwise reportable as past due,” said the regulators, “financial institutions are not expected to designate loans with deferrals granted due to COVID-19 as past due because of the deferral.
"...financial institutions are not expected to designate loans with deferrals granted due to COVID-19 as past due because of the deferral.” —Interagency statement, March 22, 2019
“A loan’s payment date is governed by the due date stipulated in the legal loan documents. If a financial institution agrees to a payment deferral, this may result in no contractual payments being past due, and these loans are not considered past due during the period of the deferral.”
The bottom line: Don’t let coronavirus get your credit score down. There may be ways within the credit scoring system to eliminate or reduce credit issues by working with lenders.
Be sure to contact creditors. If you don't call, the creditor has no way of knowing why a payment is late or missing.
How to defend your credit standing against COVID-19
Until a few days ago, late payments and no payments invariably resulted in lower credit scores and higher borrowing costs.
But we’re suddenly in new financial territory — and the old rules may not apply.
Here are three steps you can take to help bolster your credit score if your household has been affected by COVID-19:
1. Keep paying bills on time, if you can
The one sure way to maintain a strong credit score is to pay bills in full and on time without fail.
There are obvious benefits to keeping up with your regular payments:
- You control your credit report destiny. If you pay in full and on time a creditor has nothing negative to report. You’ve carried out your end of the bargain
- If you pay in full and on time you don’t have to pay late fees. The money you save stays in your pocket
But in practice, keeping up with bills can be hard — or impossible — at a time like this. In that case, it’s important to prioritize.
Take a look at the programs listed above. Talk to your lenders to figure out which loans might be exempt from credit reporting due to COVID-19, and which ones could still bring down your score.
For example, if you can eliminate one of your large debts for the time being (for example, through mortgage forbearance) you may loosen up your budget to cover other necessities.
2. Get overdraft protection
For those who are currently laid off, bank accounts might start to run short soon. If you think you might overdraw on any of your accounts, look into overdraft protection.
“Overdraft protection,” FICO explains, “taps into a savings account, credit card or second checking account if your account has insufficient funds to cover a transaction.”
“This protection could help prevent declined transactions, returned checks or additional fees. There is usually no cost to enroll — you pay only when you use the service.”
By getting overdraft protection, you could potentially protect yourself from late fees — and from accidentally overdrawing on accounts that previously had cash flow.
3. Consider forbearance for large debts
During times of hardship, creditors can offer temporary relief programs called “forbearance.”
Forbearance puts off payments for large debts like mortgage, credit cards, or student loans for up to six months or a year. During that period, you might make interest-only payments or skip your payments altogether.
The debts still have to be repaid later, but temporary relief can help protect your bank account and your credit score.
According to VantageScore, “a loan placed in a deferred payment or forbearance plan will not result in a negative impact.
“A loan placed in a deferred payment or forbearance plan will not result in a negative impact.” —VantageScore
“Rather, the loan will continue to positively impact one’s credit history and credit score, while the related balance and payment obligations under the plan will not be considered for purposes of a credit score calculation during the forbearance period.
“The net impact to a consumer’s VantageScore credit score is ‘set to neutral,’ so the consumer’s credit score is not harmed.”
4. The “let’s talk” option
It may happen that even the most responsible consumers have late payments in the new coronavirus economy.
Such delays usually set off negative credit marks, but might not in the current environment.
If you have a payment that is likely to be late or missing, call the creditor. Explain the circumstances and ask if they can waive or reverse any late fee and not report the matter.
You might find that creditors will be accommodating. After all, several industries have asked for huge bailouts while the banks have gotten $1.5 trillion in help from the Federal Reserve.
And the Consumer Financial Protection Bureau (CFPB) says it has “encouraged financial institutions to work with their customers affected by the coronavirus.”
COVID-19 was dubbed a “natural disaster” — what that means for you
In “normal” times, lenders don’t offer tons of flexibility for borrowers who miss payments. They might make exceptions in cases of particular hardship. But for many, late or missing payments lead to fees and eventually foreclosure.
However, disasters sometimes happen that wipe out entire communities’ credit at no fault of their own. In cases like this, lenders will change the rules to be more forgiving of debt repayment.
This is called “natural disaster coding” (because natural disasters frequently have a deep and widespread impact on consumer credit).
During times of natural or “declared disaster” (like COVID-19), late or missed payments may not count against your credit score. VantageScore has already exacted this measure on its credit reports. FICO is likely to follow.
VantageScore explains natural disaster coding this way:
“The credit reporting systems and standards also allow lenders to accommodate situations where consumers’ ability to meet their debt obligations are adversely affected by circumstances that are beyond their control, like a natural or “declared” disaster or, in the case of COVID-19, a public health emergency.”
Natural disaster coding protects your credit score by letting the lender know that factors outside your control are impacting your credit. As long as the disaster lasts, missed or late payment won’t count against your score.
Says VantageScore:
“When accounts are reported with a natural disaster reporting code, information that would normally have a negative impact on a consumer’s credit history is instead “set to neutral” and thus is not included when calculating the consumer’s credit score. Positive information already in the file, such as the account’s positive payment history, is retained.
The net impact is that a consumer’s credit score reported by VantageScore credit score will not go down— either because negative information is neutralized because of the natural disaster code, or because the account is completely removed.
Credit ranges before the coronavirus credit score (what’s at stake)
Before COVID-19 hit the U.S., unemployment levels were at historic lows. As a result, American credit scores have been on an uptick in recent years.
Fair Isaac (the creator of FICO scores) says the average credit score last September reached 706 — the highest on record. If 706 is the average then it follows that half the scores are lower.
So, where does your credit score currently fall? The percentage of people in each credit range looks like this according to Experian:
- Exceptional credit (800-850): 21% of the population
- Very Good credit (799-740): 25%
- Good credit (739-670): 21%
- Fair credit (580-669): 17%
- Very Poor credit (579-300):16%
With coronavirus credit scores we may see many people slip into lower credit brackets.
As credit falls, consumers have less access to affordable debt. In turn, they might start missing payments — and credit falls further. This creates a cycle that’s very difficult to escape.
That’s why fast action from the government to protect U.S. credit is so crucial.
And that’s why it’s also worth talking to your creditors individually, and doing all you can to stop your credit from slipping at this time.
The bottom line
The economic impacts of COVID-19 are out of consumers’ hands. That’s why the government, banks, and credit agencies are acting swiftly to protect Americans’ wallets as much as possible.
But there’s no denying that the effects of the coronavirus will be deep and far-reaching. So it’s important to be prepared.
Get familiar with laws that have been enacted in your area, protecting households against eviction, utility shutoffs, and more.
And if you foresee trouble keeping up with debts, talk to your lenders sooner rather than later.
Financial institutions have extra flexibility to help their customers right now. Many will be able to find solutions that forestall their debts and protect their credit until this crisis is over, and the nation’s economy gets back on its feet.
