As inflation soars and interest rates climb, many Americans are preparing for the possibility of a recession. Despite low unemployment rates, many are struggling under the pressure of the highest inflation the U.S. has seen in half a century.
If you have debt that you need to pay off and are struggling to make ends meet under the current economic conditions, you may wonder how to pay down your debt while staying financially afloat. Paying off debt before a recession, especially variable or high interest debt, is important. However, saving money during economic uncertainty might be more important, especially if you don’t have much of a safety net.
If you are unsure how to manage your debt during a recession, the information below will help you decide what financial decisions are right for you.
How to manage debt during a recession
With a potential recession looming and many Americans struggling to cover monthly expenses, it can be difficult to decide whether to focus on building your savings or trying to pay down high-interest debt before the economy gets more unstable.
The answer depends on your current financial stability. If you are financially secure and have emergency savings, you should prioritize paying down high interest debt while the economy is more stable. This is especially true if you have a loan or line of credit with variable interest rates.
If you are struggling to make ends meet or don’t have a stable income or an emergency fund, it is likely best to focus on saving. You should still make the minimum payments on your debts to avoid hurting your credit and accruing fees, but establishing an emergency fund is ultimately more important than paying down debt.
If you focus on paying down your debt before the economy becomes more unstable, here are some methods that could help.
Paying down credit card debt before a recession
If you have credit card debt, you should prioritize paying it down since credit cards come with higher interest rates than most other types of debt. The current average credit card interest rate is 17.85 percent, and rates are even higher for low credit borrowers. Since credit cards are variable rate products, the interest rate on your credit card debt is likely to continue rising if the Federal Reserve raises interest rates again as expected.
It is worth talking to your credit lender and seeing if you can negotiate a lower interest rate, especially if your credit score has improved since you applied for your card. It is also a good idea to write out how much you owe on each credit card and the interest rate and monthly minimum payment for each card. You should do so if you can pay off your debt completely or at least make a higher monthly payment than the minimum.
Paying down loan debt before a recession
Unlike credit cards, most personal and auto loans come with fixed interest rates. This means borrowers who already have these loans do not need to worry about their interest rates rising during a recession. Additionally, many personal loans come with prepayment penalties if you pay off your loan early.
If you have a fixed-rate personal or auto loan and you can afford to make the monthly payments, you should just continue to do so. However, if you struggle to make monthly payments, it could be worth looking for a lower interest product and transferring your debt.
If you have good to excellent credit, you could talk to a financial advisor about transferring your loan debt to a 0 percent APR balance transfer credit card or a home equity line of credit to get a lower interest rate. However, you should only do this if you have good credit.
If you do not have good credit and are worried about being able to pay off personal or auto loan debt, your best option is to rework your budget and prioritize paying down your debt. This is especially important if you have a secured loan so that you don’t risk losing your car, home or other valuable assets.
What if you can’t afford to pay off your debt?
If you, like many Americans, are struggling to manage your debt and are worried about the additional financial strain a recession might cause, you still have options. If you’re finding it harder and harder to manage debt payments on top of your other expenses, consider one of the following options.
Debt consolidation allows you to combine several high interest debts into one new loan, ideally with a lower interest rate. This new loan is then used to pay off all your debts, and you only have to make one monthly payment. Many debt consolidation lenders offer to pay your creditors directly.
Debt consolidation is especially good if you have variable interest credit card debt and can qualify for a fixed interest debt consolidation loan. You can also consolidate debt by transferring balance to a credit card with a 0 percent APR introductory period. You should only consolidate your debt if you are confident you will qualify for a lower interest rate than what you currently pay.
If you decide to work with a debt settlement company, you will have to stop paying your creditors while the debt settlement company negotiates with them on your behalf. Ideally, your creditors will agree to a lower sum, and you will establish a payment plan.
However, debt settlement is risky and should only be pursued as a last resort. Your creditors do not have to work with a debt settlement company and could sue you for defaulting on your payments. Additionally, defaulting on your debt payments will harm your credit score and your ability to borrow money in the future.
If you are struggling with debt and need a professional opinion about your situation, you should consider working with a non-profit credit counselor. Many reputable credit counseling agencies will advise you for little to no cost. You can also set up a debt management plan with these agencies wherein you pay them monthly and pay lenders on your behalf. This service simplifies the process for you but requires an additional monthly fee.
Talk to your lender
If you are experiencing financial hardship, it is worth reaching out to your lender to negotiate a temporary payment pause or reduced interest rate. Some lenders may even provide relief options during an economic downturn.
The bottom line
Ultimately, the best things you can do to financially prepare for a recession are to establish an emergency fund, pay down or consolidate high interest debt, and establish a consistent budget. Above all, having an emergency fund to always cover your basic needs is the most important thing. Without that safety net, you could get even further into debt during times of financial hardship. If you are struggling to make monthly debt payments, consider one of the alternatives outlined above. However, it may be wise if you have variable interest debts and can afford to pay them off.