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In times of economic uncertainty, many Americans are becoming more cautious about how they spend their extra cash. But if you’re also in debt, you might be wondering how to prepare for a recession and what impact it might have on your finances.
Here’s why a recession could be a possibility in the near future and the different strategies you can use to get your debt under control in a recession.
Strategies for Managing Debt Before a Recession Hits
Lisa Kirchenbauer, CFP and founder of Omega Wealth Management, emphasizes that managing your finances before a recession hits is all about striking a balance. While paying off debt is important, it may not be the smartest decision if it takes all your cash away.
After all, you may need to have an emergency fund on hand if you are unlucky enough to lose a job in the future. According to data from the Pew Research Center, 15% of American adults faced at least one spell of unemployment in 2020, the last year the United States experienced a recession.
But if you’re determined to pay off your debt while the economy is stable, here are some strategies you can use to get closer to the finish line.
How to pay off credit card debt
If you have a balance on your credit cards, you can pay a lot of interest over time. According to the Federal Reserve, in March 2022 the average credit card interest rate was 16.17% on assessed interest accounts. However, Kirchenbauer points out that some card rates can be even higher, especially for borrowers with lower credit scores.
Let’s say you have $5,000 and your credit card variable APR is 16%. If you pay $200 a month, it will take you 31 months to pay off your debt and you will be charged interest of $1,112. And with interest rates going up, you could end up owing even more interest.
If your cards already have balances, Bruce McClary, senior vice president of memberships and communications for the National Foundation for Credit Counseling, recommends talking to your lender.
It says if your credit score has improved since you first applied for your card, you may be able to negotiate a lower interest rate, which could save you money in fees. of interests.
How to repay personal loans
If you’re having trouble managing the monthly payments on a personal loan, Kirchenbauer recommends determining if it’s possible to transfer the debt to another financial product with a more affordable interest rate. She suggests looking into a 0% APR balance transfer card or a home equity line of credit.
However, debt transfer can involve risks. If you pay off your personal loans early, it may result in a prepayment penalty, which is a fee your lender may charge you if you pay off your loan sooner than expected. Kirchenbauer adds that 0% APR cards and HELOCs may only be available to those with very good to excellent credit scores.
For those with low credit scores, Todd Christensen, the education manager at Debt Reduction Services, Inc, a nonprofit financial counseling agency, says reworking your budget may be your best bet. “It’s not extravagant,” he says, “but cutting non-essential expenses or starting a side business to generate extra income can go a long way in helping you meet your payments.”
How to pay off student loan debt
Most Americans with federal student loan debt can rest easy for now, as their payments are suspended until August 31, 2022. And President Biden has dangled the promise of student loan forgiveness to millions of people. borrowers.
Private student borrowers, on the other hand, may not be so lucky. Yet, while there is no blanket forbearance program, many lenders have offered extended forbearance options in the wake of the pandemic. For example, CommonBond allows its borrowers access to a special natural disaster forbearance program, which allows loans to remain in forbearance for up to 30 days after the end of the national emergency declaration.
Forbearance pauses your payments for a set period of time while you get back on your feet and may be an option to consider if you are having trouble keeping up with your payments in the future. But keep in mind that interest may continue to accrue on your loan, which means this move may end up costing you more money in the long run.
How to pay off your mortgage
Unfortunately, according to Todd Huettner of Huettner Capital, the time to refinance your mortgage and lock in a lower interest rate has probably passed, as the average mortgage rate is now above 5% (compare it to 2.65% in January 2021).
Huettner says that if you’re in a situation where you have to choose which debt to pay off, homeowners should try to prioritize their mortgage payments because their home is likely their most valuable asset. “Even if you have to sell something valuable to make the payment, having a roof over your head is well worth the cost,” he says.
If you are experiencing temporary financial difficulties such as job loss, you may be able to get help from your lender. Like student loans, many mortgage officers offer forbearance programs for those who need help. In situations where difficulties persist over the long term, your lender can also help you explore more drastic options, such as a short sale.
While selling your home isn’t ideal, in many cases a short sale is considered a better option than defaulting on your mortgage and losing your home to foreclosure, as the impact on your credit scores is less important.
What steps should you take if you cannot repay your debts?
Unfortunately, even if you follow the tips above, it’s not always possible to get your debt under control. Here are some steps you can take if it becomes increasingly difficult to track your payments.
- Reduce your budget: Reducing your budget should always be your first line of defense. Reducing — or even pausing non-essential spending for the time being — can give you more leeway to pay down debt. If you want to make sure your money is going to the right place, consider setting up autopay, which allows your creditors to take payment directly from your account, or setting aside the funds in a separate savings account. .
- Work with your lender: If you’re having financial difficulty, lenders may allow you to find an alternate method of payment, such as temporarily suspending your payments while you get back on your feet or setting up a payment plan with a lower monthly payment or interest rate. more affordable interest.
- Credit advice: If you’re going into more debt, consider getting credit counseling from an accredited nonprofit agency. Many reputable agencies offer counseling services at little or no cost to you.
- Debt Consolidation: Debt consolidation allows you to streamline multiple debt payments into one and can help you save on interest. Typically, borrowers do this by taking out a new loan and using the funds to pay off their existing balances. You may have to pay fees on the new loan, which can increase your total borrowing costs.
- Debt settlement: With this method, your creditors agree to accept less than they are owed in exchange for payment under a court-ordered repayment plan. Kirchenbauer says to be aware that debt settlements are reported to major credit bureaus and will negatively impact your scores, which may impact your ability to be approved for affordable financing in the future. Since debt settlement hurts your credit and you’ll likely have to pay legal fees, she says it should be considered a last resort.
Is a recession looming on the horizon?
When wondering if we are headed for an economic downturn, it is important to understand how the term “recession” is defined. By definition, the National Bureau of Economic Analysis (NBEA) considers a recession to be two consecutive quarters of economic decline in gross domestic product (GDP). However, in practice, most financial experts tend to take a broader view, looking at declines in activity across the economy as a whole.
The NBEA shared in its latest analysis that GDP shrank 1.4% in the first quarter of 2022, leaving many to suspect that a recession could be in the cards. For example, a new Deutsche Bank report predicts a recession by the end of 2023, and Fannie Mae analysts recently released a similar forecast.
Nevertheless, it is important to remember that predictions are only educated guesses and may not turn out to be correct or provide a complete picture of what will happen.
As Kirchenbauer points out, “The problem is that [the GDP] is a lagging indicator. We won’t know we’re in a recession until it’s already upon us. So it’s even more crucial to take stock of your finances and think about the impact a recession could have on you.