How to pay down debt during a recession
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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. Beyond all of that, the majority of economists we surveyed said they expect us to enter a recession by mid-2024.
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. 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.
To help you prepare for whatever the economy brings, we have a few tips.
Evaluate your budget with a recession in mind
When the economic outlook seems favorable, many people live it at the top of their budget. But the way things look now, we should likely be tightening the purse strings.
Go through your budget category by category. If you have anything you can part with now — like an excess streaming service or a gym membership you rarely use — nix it.
Don’t stop there, though. Make a list of places where you could scale back if needed. Are you shopping at the nicer grocery store in your area? Have you been getting gas at the convenient-but-more-expensive pump? Flag places where you could make cuts if things get tough. Knowing you can adjust your budget gives you two things: an action plan and the peace of mind that comes with it.
Look for additional work if possible
While unemployment rates continue to stay low, a looming recession means companies will likely start making cuts. As with your budget, look for ways to develop a plan B here.
That could mean starting a side hustle or picking up a few shifts at a local retailer or restaurant. Sock away that extra money to help pad out your savings or apply it to your payments if you have high-interest debt.
Ideally, nothing will happen with your current employment. If something does, having another income stream in place can help you stretch your emergency fund further. And if a recession does come in full force, competition for these extra gigs will increase. Get a foot in the door now.
Do whatever you can to make the minimum payment
Making your debt payments should be your top priority, right up there with keeping yourself housed. If you don’t, your credit score takes a hit. That means borrowing money in the future will get more expensive.
First, don’t let yourself miss a payment because you simply forgot. Set up a reminder system for yourself. That could mean using the calendar on your phone or putting a sticky note somewhere you know you’ll see it.
Secondly, prioritize the money you need to make those minimum payments. If your bill isn’t due for another week, it can be tempting to dip into that pot. Don’t. Missing your minimums only adds to your debt, making your life much harder if a recession hits full force.
If you really struggle with this, you might want to open up a new account with your bank where you specifically store money for your debt payments. Once that account is open, transfer what you know you’ll need each time you get a paycheck.
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 more than 19 percent, and rates are even higher for borrowers with low credit scores. 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. This can help you see the path toward paying off your debt completely or at least making a higher monthly payment than the minimum.
If you struggle to make the minimum payments and cannot negotiate with your lender, it may be worth considering debt consolidation or working with a debt relief company.
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 can afford to make the monthly payments, you should continue. 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 debt consolidation loan with a fixed rate. You can also consolidate debt by transferring your balance to a credit card with a 0 percent APR introductory period — assuming you can pay all or most of that debt before that 0 percent period expires. You should only consolidate your debt if you are confident you will qualify for a lower interest rate than what you currently pay.
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.
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 they pay lenders on your behalf. This service simplifies the process for you but requires an additional monthly fee.
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.
If you are struggling to make monthly debt payments, consider one of the alternatives outlined above. Above all, having an emergency fund to 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.