A recession can hurt your finances, so it’s important to be mindful of your spending and avoid taking unnecessary risks that could jeopardize your financial goals. Below are some of the financial risks everyone should avoid taking during a recession which can be weathered by being prepared and taking a few simple steps to reduce your risks.
Becoming a Cosigner
If the borrower does not make the required payments, the cosigner might have to make them instead–a very risky commitment even in flush economic times. Since the borrower and the cosigner may face an elevated likelihood of losing a job or seeing a decline in business income, the risks associated with cosigning on debt are even higher during an economic downturn.
If you have to cosign for a family member or close friend, it’s best to have some savings aside. It may be preferable to assist with a down payment or make a personal loan instead of cosigning and leaving yourself on the hook for the loan.
Getting an Adjustable-Rate Mortgage
An adjustable-rate mortgage (ARM) may be a good choice if interest rates are low because the monthly payment will stay low. Adjustable rates for loans taken out during a recession are more likely to rise once the downturn ends because interest rates usually fall early in a recession and then later rise as the economy recovers.
What is the worst that could happen? You lose your job, and interest rates rise as the recession wanes. Your monthly payments go up, making it extremely difficult to keep current on the payments. If you have late or don’t pay, your credit score will go down, making it harder to get a loan later.
Assuming you have decent credit, a recession may be a good time to lock in a lower fixed rate on a mortgage refinance. However, be cautious about taking on new debt until you see signs the economy is recovering.
Assuming New Debt
Assuming more debt may not be an issue when you’re earning enough money to make monthly payments and still save for retirement. However, during an economic downturn, the risks increase, including the possibility of being laid off or losing business income. If that happens, you may have to take a job that pays less than your previous salary, which could affect your ability to pay your debt.
If you are considering adding debt to your financial equation, understand that this could complicate your financial situation if your income declines. Taking on new debt in a recession is risky and should be cautiously approached. If you can, pay cash or wait on big new purchases.
Taking Your Job for Granted
Even large corporations can come under financial pressure during an economic slowdown, leading them to look for cost cuts, which often means layoffs.
Older workers who retire during a recession could see their income decline and their retirement portfolio suffer just as they start to draw it down.
Making Risky Investments
As a business owner, you should always consider the future and ways to grow your business. However, it may not be the best time to make risky bets during an economic slowdown. Early on in a recession is not the time to start thinking big. Later, once the economy starts to show signs of a sustainable recovery, it is time to stick your neck out.
Although it may sound appealing to borrow to add space or increase inventory—particularly since interest rates are likely to be low during a recession—you may not be able to make interest payments on time if business slows down more. Leading economic indicators for your market or industry turning up is the cue to start considering investments, not when interest rates start to tick upward.
The Bottom Line
You shouldn’t panic in response to an economic slowdown, but you should pay extra attention to spending and be wary of taking unnecessary risks. You can take many positive steps to improve your situation and recession-proof your life, even amid a significant economic downturn. Adopting a realistic budget, establishing an emergency fund, and generating additional sources of income are all important steps to take.
