Credit is the lifeblood of the economy.  The essence of the financial crisis that we are experiencing and the reason the government has had to use taxpayers’ money to rescue financial institutions from collapse is that credit was frozen.   Banks were hoarding cash because they were afraid of lending money to others and take the risk of not getting their money back.  Once credit freezes, everything suffers.  Businesses can’t get cash to finance their operations, financial institutions can’t borrow money to manage their cash flow needs, builders can’t finance their construction projects, individuals can’t finance car and home purchases.  Once that happens, the economy goes on a downward spiral in what is commonly known as a recession.  And that’s where we are right now – make no mistake about it – in the middle of a painful recession.

Credit is a major component of macro-economics, but it is also one of the most important aspects of financial success for individuals.  Therefore, it is extremely important that you protect the key measurement of how successfully you manage credit – your credit score.  In the article Build Financial Success with a Strong Credit Score we go into detail on how to manage your credit score.  In addition to the steps laid out in that article, you must also be careful to protect your identity, because identity theft can have a very significant negative impact on your credit score and your financial health.  For more information see the article How to Protect Your Identity.

We have talked in the past about the importance of managing credit, but the reason why we keep coming back to this point is that it is so extremely important for your financial success.   As we work through the worst financial crisis since the Great Depression, and have to deal with the possibility of a deep and long recession, it becomes even more critical that you manage credit well.

Now let’s get to the bottom line.  In order to be financially successful in this environment of frozen credit, here is what you need to do:

Cut back Your Spending

This is the time to be very conservative with your spending.  No one likes to hear this “tough love” piece of advice, but this is perhaps the most important message you need to hear: you must live below your means, no matter how difficult it may seem.

Build Your Cash Reserves

As you cut back on your spending, build a cash reserve with any money left over from your income.  You should target to have at the very minimum six months of living expenses stacked away in a very safe, conservative investment such as a bank savings account.

Pay Off You Debts

After building your cash reserve, the next step is to start paying off your debts.  You should start with your highest interest rates debts first, and then work your way down to eliminate your debts one by one.

Review Your Credit Cards

Credit cards are very convenient and can be used to your advantage if managed properly.  If you are unable to pay off your credit card bills every month, look for credit cards with low interest rate.  For those of you that are better at managing your debt and can pay off your credit card balance every month, look for credit cards with the best rewards, such as cash back, or points that can be used for airline travel, etc.  Many of the sites that help you research credit cards online also provide you with credit card application that is convenient and easy to fill out.

Once you have found a couple of credit cards that work well for you, get rid of the other ones.  Don’t close your credit card account because that could hurt your credit scope. Simply cut up your credit cards and throw them in the garbage.

Downsize if Necessary

Don’t be ashamed of downsizing.  If you are living in a house that is bigger than you can afford, you must downsize right now.  Now more than ever, you must do the right thing for you financially and not worry about appearances.  In fact, frugality is becoming fashionable.  Take advantage of this trend to straighten out your finances.

This recession will be painful, no doubt about it.  By following the steps above you will be in a much better position to ride out the storm and come out stronger once this one is behind us.