Coping with debt when you’re laid off

Layoffs can happen to anyone, and they never seem to happen at a convenient time — especially if you have debt. Credit card debt, in particular, can feel overwhelming even when you are employed, and many people struggle to make ends meet after being laid off or furloughed.

Although it can be challenging to continue meeting your debt obligations and protect your credit score when you’re out of work, it is possible. Here’s what you need to know about coping with debt when laid off.

First steps to take when unemployed

“After losing your job and dealing with debt, staying calm and planning your next steps is essential,” says Mark Hirsch, founder of Prime Time Business Network.

When you’ve just lost your job, here are a few steps you can take immediately to protect your finances.

Contact your creditors

If you’ve just been laid off, it’s a good idea to contact your creditors promptly to explain the situation. Sometimes, credit card issuers and other lenders can help by moving back your payment due date or even offering you access to a hardship program. 

Hardship programs are payment plans that credit card issuers, mortgage lenders and other creditors offer for customers with financial emergencies. Typically, they’re intended to last for a short time. 

In a hardship plan, the creditor may lower your interest rates or waive any fees. The terms of these hardship programs vary widely depending on the institution, your history with the lender and your financial circumstances.

However, note that using a hardship program for a credit card may harm your credit score. Some card issuers will close an affected credit card account or lower your credit rating as part of the plan. Likewise, if the creditor lowers your credit card limit, your credit utilization ratio — the percentage of available credit you use — may increase and ding your score.

Apply for unemployment benefits

Apply for unemployment insurance benefits as soon as possible following a layoff. Unemployment insurance helps provide income to eligible workers who have lost their jobs through no fault of their own.

It’s up to each state to determine its eligibility requirements and benefit terms. However, benefits are generally based on your work history. 

Unemployment benefits are intended to be temporary, and you’ll need to meet your state’s requirements for claiming benefits and actively seeking a new job. However, they can be a lifeline while you find your next position, helping you meet your financial obligations in the interim.

Get on a budget

After a layoff, budgeting can help you get a clearer picture of your income and expenses. It can help you identify overspending habits and determine how much money you can save.

“In today’s economy, inflation and rising interest rates can make it challenging to stay within a budget,” notes Michael Hershfield, founder and CEO of Accrue Savings. “Keep track of your income and expenses and create a realistic budget for yourself. Sticking to a budget can help you pinpoint where you can cut unnecessary costs that can go toward paying off your debt.”

Hershfield suggests using the 50/30/20 rule when creating a budget. Under this rule, 50 percent of your income should go toward “needs” — essential items such as housing, transportation, food and bills. Meanwhile, 30 percent goes toward “wants” — the things that make life more enjoyable. The remaining 20 percent should be earmarked for saving and paying off your debt. 

When creating a budget in a financial emergency, remember it’s likely only temporary. When you’ve been laid off, you may want to pare back on the “wants” category and put more toward paying off debt.

Avoid using credit cards or loans to cover expenses

Generally, you should not make a purchase on credit or get a loan that you can’t afford to pay off. If you are unemployed, avoid using your credit cards to cover the expenses you can no longer pay for in cash.

As one of the first steps you take following a layoff, Hershfield says you should “put away your credit card.”

“Try working within a budget, and utilize your debit card,” he says. “This will assist in providing you with insight and a sense of what you are spending.”

However, many people do use their credit cards or personal loans as a financial lifeline when they are unemployed, especially if they don’t have an emergency fund. If you decide to use credit to cover the income gap during unemployment, remember that whatever you purchase now must be paid off later — with interest. Try to keep your balances to a minimum.

How to prioritize debts when you don’t have income

When you’ve just lost your job, it may feel tempting to ignore your financial woes. However, that will only make matters worse.

Skipping your loan or credit card payments will likely lead to a lower credit score. This can make it difficult to take out another credit card or receive a favorable interest rate in the future. Your account may be sent to a collections agency if you skip multiple payments. In some cases, missed payments could lead to a lawsuit from a creditor.

You can avoid skipping payments and damaging your credit score by focusing on making the minimum payments on your accounts. Minimum payments keep your account in good standing with your lender and the three credit bureaus, and you won’t get charged late fees or penalty APRs for missing payments.

Aside from making your minimum payments, you can try to pay down your highest-priority debts if you can. There are several effective methods for repaying debt, including:

• The debt snowball method: Pay off the smallest debt first, while making minimum payments on the others. Once you pay it off,  you can put the extra money toward the next-smallest debt. Repeat the process until you’ve paid off all of your debt balances.
• The debt avalanche method: This method is similar to the debt snowball, but it focuses on the debt with the highest interest rate first.

Additional help when you get laid off

If you’ve been laid off and have a large amount of debt, you may want to look for additional help.

Credit counseling agency

It may help to contact a credit counseling agency for advice. These nonprofit organizations provide education and support — often for free — to consumers struggling with debt. They can help you create a debt repayment plan for a small fee.

Bankruptcy

While not ideal, bankruptcy is an option if your debts are out of control. Talk to a bankruptcy attorney for the best advice on how to approach this option.

It may be best to wait until you have a new job to file for bankruptcy. It will be easier to rebuild your credit and keep up with expenses if you wait until you have a more stable income. You also would struggle to have a payment plan with Chapter 13 bankruptcy if you don’t have an income.

Debt settlement

Some people look into a debt settlement program to make paying it off more manageable. Debt settlement programs can help you manage debt by negotiating a payment plan with your credit card companies. Typically, the settlement company will require you to stop making monthly payments and instead contribute funds to an escrow account. The company will then attempt to use the money in the account to settle the debt for a lower amount. 

If you’ve been able to maintain your monthly minimum payments up to this point, be aware that using a settlement company will lead to a lower credit score. 

Debt settlement also has many risks, including that creditors aren’t required to work with you, and can look worse on your credit report than a bankruptcy. Settlement should only be a last-resort option.

The bottom line

Losing your job can be a serious financial blow — especially if you have debts to pay. But by keeping a cool head, communicating with your creditors, making a plan and sticking to a budget, you may be able to keep making payments and avoid damage to your credit score. Odds are, your creditors would rather work with you than send your account to collections.

In addition, many resources exist to help people who have lost their jobs through no fault of their own, from government unemployment benefits to nonprofit credit counseling services.

Frequently asked questions

• Can you qualify for a new credit card while unemployed?

  If your household brings in enough income, you might be eligible to qualify for a new credit card even while unemployed.

  You might also consider a secured credit card, which allows you to secure a line of credit by putting down a deposit. Secured credit cards may not give you much purchasing power, but they can help you build a solid credit history while unemployed.

• Will filing for unemployment affect your credit score?

  Filing for unemployment benefits will not affect your credit score. Your FICO Score is based on five major factors: payment history, credit utilization, length of credit history, credit mix and age of credit.

  As long as you can maintain a positive payment history and avoid running up high balances on your credit cards, your credit score should remain stable regardless of your employment status.

• Should you withdraw money from your 401(k) to pay off your debts?

  Using your 401(k) to pay down debt while unemployed should be a last resort. Taking early withdrawals from your 401(k) comes with serious consequences. You’ll pay taxes on the money you withdraw, plus an early withdrawal penalty. You’ll also lose out on any potential growth on the fund you withdraw. These penalties might apply even if you take a qualified hardship withdrawal.