How Unemployment Affects Credit Scores

Unemployment has very little direct impact on your credit score. However, it could indirectly have a significant effect and cause your score to decrease.

During periods of unemployment there is generally a significant reduction in income while receiving unemployment benefits. Credit bureaus do not recognize that you are on unemployment, but they do recognize a reduction in income and this causes a slight decrease in your score.

If unemployment causes the bank to foreclose on your home your credit score will drop dramatically. A foreclosure will remain on your credit report for seven years.

However, a significant loss in income can effect your ability to pay bills timely.  The extent to which you pay your bills consistently and timely comprises 35 percent of your credit score. A late payment won’t destroy your credit. However, If your loss in income causes you to make a habit of missing payments or paying late, your credit score will suffer. Additionally, creditors will charge late fees and even raise your interest rates after a few occurrences of late or missed payments. You will also be charged higher rates on future loans and credit lines.

Sometimes people use their credit cards more than usual to help defray expenses that they can no longer meet with income during periods of unemployment. A significant change in your debt to credit ratio can have an adverse effect on your credit score. If your credit balances suddenly spike and you have not opened a new line of credit your score will drop. This is especially true if the increased balance(s) is on a credit card(s) that you will not be able to pay off immediately. The percentage of extended or available credit that you use (maxing or close to maxing your accounts) comprises another 30 percent of your credit score. 

Some people take out additional credit cards and/or home equity loans to further defray expenses during periods of unemployment. A sudden spike in requests for new credit cards will cause your score to decrease. This is especially true if you are applying for multiple lines of credit within a short period of time. For example, if you apply for two new credit cards in a month, followed by a home equity loan the next month and a car loan the following month, your credit score will decrease. 

Note, however, that if you have multiple requests for a single type of credit, such as a car loan, within a short period, this only counts as one inquiry and does not significantly effect your score.

If you have to use home equity during unemployment be careful of how you do that.  There are two types of home equity loans you can obtain – a home equity line of credit (HELOC) or a home equity installment loan (HEIL).  Either one will give you the money you need, but one will lower your credit score and  the other does not so be careful which you choose to use.

A HELOC can look like a credit card on your credit reports.  When it is mistaken for a credit card it appears as though you have a very high credit card limit and you’re using all of its available limit. This will cause a significant decrease in your credit score.

The difference between a HELOC and HEIL is:

A HELOC is a revolving loan (like a credit card). This means you can have variable monthly payments determined by the balance you owe each month. A HELOC also allows you to take some or all of the available credit out as you need it, just like a credit card.

A HEIL is an installment loan just like your car loan or mortgage loan. Installment loans are for fixed amounts and you make the same fixed payment amount every month until its paid in full.  When you take out  a HEIL loan, you take out only a fixed amount in one lump sum.

So the basic major difference is that a HELOC could be mistaken as a credit card account by the FICO scoring model because they report as revolving accounts. A HEIL cannot be mistaken as a credit card account because a HEIL appears on your credit reports as an installment account.

Because of the effect HELOCs may have on credit scores, consider using HEILs to tap equity in your properties even though the interest rates are usually higher.

You can use this knowledge to your advantage to avoid having your credit score decrease during unemployment by “strategically” using your home equity as a source of income to keep your bills paid on time. 

Eric Folgate, a writer for offers this strategy: Apply for the highest HELOC amount you can qualify for. Just don’t use more than 10 percent of the limit. The most essential part of this strategy is your discipline after you’re approved. If you can keep yourself from going out and buying things with your new line of credit, you can really protect your credit scores.

This way, even if your HELOC is misinterpreted as a credit card, your credit scores can’t be hurt, in fact it could even help them.

So, a HELOC can be a good thing if your balance is extremely low or nonexistent.