By Mike Goldstein, Content Writer at Credit Karma
As we trace the slow recovery of American job numbers, the housing market and the national economy as a whole, the time is right to explore the interaction between economic and credit health. There is no one-to-one correlation, of course. Credit scores don't magically start rising when the NASDAQ has a good day. Still, the two elements are more intertwined than you may first assume.
The interaction between the national economy and personal credit scores is not simply one of cause and effect, but of a complicated set of shifting needs and priorities. Here are a few ways in which economic downturns can impact personal credit decisions.
Hard Times Force Tough Decisions
The recent housing crisis highlighted how tough economic times can put your credit health in a bind. As home values plummeted below mortgage debts, consumers began prioritizing credit card payments over their mortgages. The reasoning was simple - borrowers didn't want to pay off their full mortgages if their home value, influenced by national trends, was worth less. Foreclosure and eviction are usually farther off than credit card cancellations and repossessions, too, so the immediate impacts of missing mortgage payments were less than those of missing credit card bills.
This decision was risky in terms of credit health. An unsatisfied mortgage and a foreclosure could do worlds of harm to credit scores. Missed or late payments could do some damage too. Borrowers, however, did what they thought was necessary according to their financial circumstances, and the national housing crisis took precedence over credit management.
Cash Poor, Credit Needy
Finding yourself out of work or in a position of financial distress can put a lot of strain on your credit health as well. For those who don't have a steady income or whose budgets are stretched thin, making the payments necessary to keep credit scores in shape can be a difficult task. Losing your job can quickly translate into missed payments, collections accounts and other derogatory marks.
The cruel irony here is that the cash poor are the people who need good credit the most. If you're temporarily out of work and simply looking to hold down the fort for a few months while you search for a new source of income, a reliable credit card with low interest rates and friendly terms can be invaluable to your efforts. A time when you're already struggling to pay the bills might not be the right moment to go out and shop for new loans, but it certainly is a moment when having an available source of credit can come in handy. In this way, hard economic times can cause an increased stress on the credit system, as well as influence both the resources and needs of those most affected.
So, hard times can put extra, credit-related stress on anxious homeowners or the recently unemployed. How does the economy influence how lenders make decisions?
During our most recent economic downturn, many lenders became noticeably stingier. Gone were the subprime lending practices of the housing bubble, where consumers with below average credit scores were given access to high-risk loans without much hesitation. Instead, lenders raised their standards. Compared to the years before the recession, higher credit scores were necessary for the best rates and lower credit scores were less likely to garner consideration at all. The recession put a premium on healthy credit reports.
The stress of the recession also led to higher interest rates for some credit card users. In 2009, Bank of America, for example, raised interest rates on cardholders with APRs under 10 percent. The lender had been seeing an unusually high number of late payments and defaults due to the crumbling economy, and needed to recoup some of their lost profits. Financial institutions that have been hurt by an economic downturn often respond by becoming more conservative.
Here and Now
In 2014, most experts agree that we've already escaped the worst of the recent economic trouble. As the economy slowly recovers, and rough patches like joblessness and underwater mortgages become less common, the imperative to protect your credit still remains. If you're struggling between conflicting debts, it could be worthwhile to keep your credit health in mind before letting one account go completely delinquent. If, on the other hand, you're not quite struggling, you might want to take the opportunity to fortify your credit file through on-time payments, proper credit card utilization and a healthy mix of account types. Your credit score could come in handy, especially if the economy turns south again.