Roughly 800,000 federal workers missed two paychecks thanks to the record-setting partial government shutdown — and many turned to banks and credit unions for loans to help making ends meet.
It’s a decision that some, including Commerce Secretary Wilbur Ross, suggested that furloughed and unpaid workers make as the bills piled up. And some federal workers turned to other means for cash to get them through the shutdown, including personal loans, payday loans, credit-card cash advances and 401(k) loans.
But now that the shutdown is drawing to an end with President Trump’s announcement Friday that the government will reopen until Feb. 15, federal workers will need to shift gears and come up with a plan to pay off the debt they amassed over the past 35 days.
“When you get the back pay, pay off the loan, and don’t take a vacation with the money,” said Kyle Jones, a certified financial planner and principal of Aequitas Wealth Management in Los Angeles. “The back-pay is not a windfall for you, and please be responsible with any debt you’ve had to get yourself into as a result of this mess in Washington.”
Read more: How furloughed federal workers can rebuild their finances after the shutdown
Some financial experts are worried that matters may only get worse moving forward, even though workers are going to start getting paid. Jayson Owens, a financial adviser with Bright Road Wealth Management headquartered in Anchorage, Alaska, argued that taking out a loan was “a dangerous proposition” for workers who had little or no savings going into the shutdown.
“Banks are suspending typical hurdles to borrow,” Owens said. “They are offering temporary low rates. It seems like a very nice thing to do, but right off the bat, we know that this loan cohort will have a much higher default rate than typical loans, because many sub-prime borrowers will get these loans. Then they will struggle to pay them back.”
Federal contract workers are in an even worse bind than their colleagues who work directly for the government. While they too are expected to resume work imminently, lawmakers have not passed legislation guaranteeing back pay. So they will be on the hook for the debts they took on without back-pay to offset it.
Here are the steps federal workers need to take to approach the debt they have accrued, once they start getting their paychecks.
Make sure you understand the terms of your loan
Every loan has different terms. Many banks and credit unions, for instance, offered products that were advertised as 0% interest or low-interest. But in some cases, these loans technically carry adjustable interest rates. For instance, the Congressional Federal Credit Union offered a line of credit with a 0% rate for the first 60 days, after which the rate resets to 4% on the remaining balance.
Moreover, some lenders structured their loans to take into account that federal workers will receive back pay. Navy Federal Credit Union offered a 0% APR loan for workers affected by the shutdown and required prospective borrowers to provide direct deposit information when applying. But there’s a catch. “When your paycheck comes they have first claim on it,” said Brian Karimzad, co-founder and head of research at personal finance website Magnify Money TREE, +1.43%
Indeed, the credit union will automatically deduct the money it is owed from borrowers’ direct deposits once their pay resumes.
Pay attention to interest rates and fees when crafting your strategy
When making a debt repayment plan, it’s important to pay attention to interest rates, especially if workers took on high-interest debt such as payday loans or credit card cash advances.
Generally, consumers should make these their first priority, because the interest accrued can add up very quickly and make it all the more difficult to emerge financially unscathed from the shutdown.
High-interest loans aside though, consumers should do some soul-searching to decide what debt repayment strategy works best for them. Some experts recommend a “snowball approach,” where borrowers make the minimum payments on all their loans, but pay as much as they can on their smallest loan until it’s gone. Then they move on to the next largest loan and so on until their debt is wiped out.
But if a worker has a 0% interest personal loan and time to repay it, they may instead want to build up their emergency savings fund right now to give themselves a cushion in the event of another shutdown.
Workers also shouldn’t forget to keep loan fees in mind. Personal loans, unlike mortgages, don’t typically come with penalties for paying off the loan early. But if the borrower didn’t pay origination fees upfront to the bank or credit union, they will need to do so to close the loan.
So while it may be cheaper in the long run to pay off the loan early, it has drawbacks. “It inflates your effective interest rate if you pay off a loan early,” Karimzad said. <<pull quote In other words, workers won’t have the luxury of spreading out the cost of the loans fees over time. Given how financially unsteady workers may still be right now, as a result, they may not want to pay off entire loans in one fell swoop.
Also see: ‘We’ll never see that money back’ — how small business owners can recover from the shutdown
Monitor your credit score
Making payments on-time is vital to ensure that the shutdown doesn’t do lasting damage to one’s credit score. But there’s potentially a silver lining to this situation: it could actually boost a worker’s credit profile. “Having credit available does not hurt your credit score, to the contrary it actually helps your score,” Jones said.
When workers pay off a loan entirely, their credit score may go down slightly because it will reduce the amount of credit they have outstanding – but not enough to be of concern.
However, workers should keep other existing and future forms of debt in mind. If they choose to take out new loans in the near future, the credit checks lenders will run could ding their score. And if they don’t pay off their shutdown-related loans right away and then take on more debt, they would increase their debt-to-income ratio, which is also bad for one’s credit score if it gets too high.
Consider keeping lines of credit open, just in case
Some federal workers and their loved ones may have given into the temptation of borrowing from their thrift savings or 401(k) plans or using funds from a home equity line of credit.
Both of these strategies have their pitfalls. Borrowing against one’s retirement savings has major opportunity costs because the consumer will lose out on the compound growth their interest would otherwise earn. And if a borrower doesn’t pay back their home equity loan in a timely fashion, they’re putting their home at risk of foreclosure.
Nevertheless, federal workers who relied on these loans during the shutdown may not want to close them now that it’s coming to a close. “This line of credit could then remain in place indefinitely as a potential tool to use in the future, in particular if the risk of government shutdowns is ever-present,” said Kent Schmidgall, a wealth adviser and advisory team leader with Buckingham Strategic Wealth in Burlington, Iowa.
And given that President Trump only agreed to reopen the government for three weeks, another shutdown could theoretically happen.