Right now, everyone is talking about the “fiscal cliff” – the potential crisis that will occur if our elected lawmakers are unable to extend tax cuts and avert millions of dollars in spending cuts that will take effect in the New Year.
As the deadline approaches, you may be wondering what impact, if any, would the fiscal cliff have on your FICO Score?
The good news is that there is no direct effect on the score associated with the main factors driving the potential fiscal cliff. Your income and the amount of taxes you pay are not considered in the calculation of your FICO Score.
However, the failure to extend the tax cuts and/or avert spending cuts could have a negative indirect effect on credit scores. Most experts agree that just about every taxpayer would see their taxes go up next year if the tax cuts are not extended. And if you’re unable to pay your taxes, it will likely result in a tax lien being posted on your credit report, which will have a possibly substantial negative impact on your FICO Score.
The exact amount of potential tax increases would vary depending on a person’s income. According to Yahoo Finance, White House officials estimate the average U.S. family could pay over $2,000 more in annual taxes if an agreement is not reached. That estimate increases to more than $3,500 according to the Tax Policy Center if no agreement is met. That’s about $300 a month, which many people may be using right now to pay down credit card debt and cover general living expenses.
The loss of that income could cause consumers to charge more to their credit cards or not pay as much on balances owed – all actions that could increase average revolving credit utilization or even result in the posting of new missed payments. That kind of fallout would likely have a substantially negative impact on a FICO Score.
In addition, lenders may become more concerned about the potential for increased losses if the fiscal cliff looks imminent. Generally speaking, lenders will react by tightening their credit criteria, making it more difficult for people to qualify for a loan. Banks and credit unions will likely require higher credit scores before granting new credit or increasing existing credit capacity.
What to do?
The best course of action is to continue paying your bills on time, keeping your credit indebtedness at reasonable levels, and only apply for credit only when it is absolutely needed.
Additionally, now is a good time to sit down and review both your monthly living expenses and your existing credit card debt, if you have any. If you really want to be prepared, aim to put away an extra $300 a month to address the top end of the projected tax increases. If the worst case fiscal cliff scenario comes to fruition, you’ll have a nice cushion stored away for when tax time comes around. And if lawmakers manage to steer us away from the pending cliff, you can put that extra savings towards a down payment on a new home, a new car, or an investment in your kids’ future education.
Tom Quinn is the Vice President of Business Development for myFICO, and has over 20 years of experience working with consumers, regulators and lenders and regarding credit related questions and initiatives.