Smart credit card strategies before and after a job loss

The newly unemployed need to dramatically shift spending, payment habits

By Erin Peterson

There are a few bedrock principles when it comes to using credit cards wisely: Pay them off in full whenever you can, pay off balances as quickly as possible and use windfalls such as tax returns, bonuses or inheritances to wipe balances clean.

But when you're facing a job loss, all those commonly held rules go out the window, says Cate Williams, vice president of financial literacy at Money Management International, a national nonprofit credit counseling firm. "If you've lost -- or are about to lose -- your job, the No. 1 priority is to conserve what cash you have," she says.

With the median unemployment period hovering near six months -- and the prospect of a lower salary after you've landed a new job, it's best to hope for the best but prepare for the worst. Here are a few key ways to use credit cards wisely in a difficult time.

The situation: Layoffs are looming, and you've got massive credit card debt.

Smart strategy: Don't focus your energy on reducing credit card balances. Instead, build up your emergency fund, says Liz Pulliam Weston, author of "Your Credit Score." "Stop making extra payments on your credit card," she says. "You may need the cash, so in this case, paying only the minimum is the right thing to do."

Big mistake: Stop thinking of your credit cards as a good Plan B. Credit cards can be a fantastic financial tool, but they're a crummy financial backup plan. Despite new consumer-friendly regulations within the Credit CARD Act of 2009, card companies have few obligations to you. That means your credit lines can still be slashed dramatically for almost no reason at all. And don't plan on piling up new cards to fuel spending after the paychecks stop arriving, says Gail Cunningham, spokeswoman for the National Foundation for Credit Counseling. "New credit is hard to come by," she says. "Use your existing credit lines wisely."

The situation: You've just gotten a pink slip, but you're well prepared with no credit card debt and several months' expenses stashed away in an emergency fund.

Smart credit card strategy: Pay off your credit card bills -- while making sure that they're much, much smaller. If you've always paid your balances on time and in full, you can dip into that emergency fund to continue to pay off cards on time -- but only after you've cut expenses to the bone and minimized your card purchases. "You risk damaging your credit score by running up your balances, so you also want to be ruthless in cutting spending," Weston says. "Too many people put off changes by thinking everything will be better shortly, and they end up in a much worse position in just a few months."

Big mistake: Don't assume your credit card company isn't paying attention to your purchases. If you typically pay by plastic, making dramatic shifts in the kids of purchases you make can raise a red flag with your card company. Going from Dolce & Gabbana to the Dollar Store -- or making a few extra trips to that hole-in-the-wall bar down the street -- may cause your card company to take a closer look at your financial situation. "We're learning more about how banks are using behavioral formulas to determine who may be a high-risk customer," she says. "Big changes might cause your account to come up for review." That could mean higher interest rates or slashed credit, which is exactly what you don't need at a critical time. Paying in cash can help you avoid the scrutiny.

The situation: You've been laid off, and you have just a month or two of living expenses in a small emergency fund.

Smart credit card strategy: Pull way back on credit card spending and make the switch to cash whenever you can. This strategy will make you more conscious about your spending -- and help you save some serious dough when you need it most. "It's too easy to go to a drugstore to pick up a prescription and then pick up a few snacks or skin cream, then put it all on a card," Williams says. "Suddenly that $12 prescription is costing you $36, and you can't afford to do that. Fortunately, stores still accept cash."

Big mistake: Avoid the lure of easy money. Cash advances can be tempting, because they'll give you quick access to the cash you may need weeks or months down the road to pay for things you can't put on a credit card, like rent, a mortgage and some utilities. But sky-high fees and interest rates rarely make it a good bet, says Cunningham. "It may seem like a good idea to have this financial safety net, it's likely that you will end up the loser," she says. "Adding debt when your income is compromised is never a good idea."

The situation: You've lost your job, and your paycheck-to-paycheck lifestyle means you're going to be strapped for cash in a matter of weeks.

Smart credit card strategy: Be upfront with your creditors. Call the card company and explain the situation; you're likely to get better treatment if you give them advance warning instead of waiting until you've missed a payment, says Cunningham. "Most major credit card issuers have in-house help programs," she says. "They may be able to temporarily lower your monthly payment and reduce interest."

Big mistake: Don't misuse your cards when the situation gets serious. Using credit cards even after you know you're going to have to file bankruptcy isn't just unethical -- it may be illegal. "If you keep using a credit card even after it's clear that you're insolvent, that can be considered fraud," says Weston. "After it's clear you can't pay anymore, you've got to put the cards away."

See related: 5 tips for tackling debt when unemployed, What you buy, where you shop can affect your credit, Cutting expenses? Go BIG!

Published: September 17, 2010

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