Never heard of “recession-day preppers”? It’s a new term the Debt.com team coined to refer to people who envision another financial meltdown just over the horizon. It’s the money version of a doomsday prepper. And like doomsday prepping, recession-day prepping only sounds crazy until the next recession hits… which it inevitably will.
Whether you believe in the possibility of Recession 2018 or not, it’s a good idea to shore up your budget. If the worst happens, you’ll be glad you reinforced your finances to weather the storm. You can be the dependable, financially stable ant in a weak economy full of consumerist grasshoppers who failed to plan.
The guiding recession-proof principle: Savings good, debt bad
If you want to recession-proof your budget, your actions will revolve around two tasks:
- Reduce your debt
- Increase your savings
Less debt means less risk of default and more borrowing power in case you need it. More savings provides a bigger safety net if you encounter any issues with employment.
Step 1: Systematically minimize debt levels
Start with high interest rate credit cards first. Ideally, you want to maintain zero balances from month to month. So, everything you charge in a month gets paid off within that billing cycle. This minimizes interest charges, but it also helps protect your finances from risk during a recession.
If a recession hits, you don’t want excess credit card debt hanging around. It gives you less breathing room in your budget, because you have more obligations to cover. If the worst happens and you lose your job, credit cards are often the first debts to slip into default.
That means if you believe a recession may hit in 2018, you should take steps throughout the year to eliminate your credit card debts. If you can’t pay off the balances using a debt reduction plan in your budget, consider relief options:
- Credit card balance transfer
- Unsecured personal debt consolidation loan
- Debt management program
Once you have credit card debt out of the way, focus on any student loan debt in your household. If you have multiple federal loans to repay, consider debt consolidation. You can also use a standard or graduated repayment plan. These plans are designed to help you eliminate your student loan debt quickly and efficiently.
Step 2: Increase the size of your financial safety net
In normal circumstances, experts say you should have 3–6 months of bills and budgeted expenses covered in savings. For example, let’s say your bills and necessary expenses cost $1,500 per month. A good emergency savings fund would be $4,500 to $9,000. This would allow you to maintain your budget without credit even if you lose your job for up to six months.
However, during a recession, 6 months may not be enough. During the Great Recession, people were unemployed for up to a year or more. So, experts now say that if you anticipate a recession, you should save up to 1 year of expenses. Ideally, you want $18,000 in savings.
If that sounds excessive, just remember what this money is supposed to cover. The idea is that you can live on savings until you get a new job. No massive run up of credit card debt; no payday loans with ridiculous interest rates. You enjoy financial peace of mind even without full time employment.
3 key takeaways from the Great Recession as you recession-proof your finances now
#1: If you think there’s a chance of recession, don’t do anything risky with your mortgage
Arguably the most devastating part of the Great Recession was the real estate market collapse. It was certainly heart-breaking to watch people lose their 401(k) savings in the stock market crash, but most eventually recovered. But when the mortgage market collapsed, families lost their homes and in many cases, there was no going back.
A large part of the mortgage crisis resulted from excessive borrowing against equity. People took advantage of the boom years to take out second and even third mortgages. They used home equity loans and HELOCs without reserve or concern. But when the market collapsed and property valued plummeted, those homeowners were severely upside down. They owed far more than their homes were now worth.
The hard lesson learned during that crisis was that borrowing against your home can be risky. Just because you have equity to use, it doesn’t mean that you should. If you worry about a recession, stick to a single traditional mortgage and don’t borrow against your home. In particular, avoid actions like taking out a home equity loan to pay off credit card debt. It’s just not worth the risk!
#2: No job is 100% recession-proof, but some are recession-susceptible
There’s no guarantee that you can make it through a recession without hiccups in your employment. However, the Great Recession certainly showed the vulnerability of several professions:
- Anything in construction or real estate can be risky. Recessions don’t always come with a mortgage crisis, but a weak economy often leads to a housing market slowdown. If your career is dependent on an active health real estate market, you may want to consider supplementing your income.
- Hospitality is hard when everyone stays home. People in the service industry also suffered particularly hard during the Great Recession. As families felt the financial pinch, they stopped going out to eat and limited vacations. As a result, tips dried up and people’s customer base just wasn’t there.
- Startup businesses have a higher risk of closure. You don’t have any guarantee that a large company will weather the storm and avoid mass layoffs. On the other hand, working for a startup means you may be more at risk of the business closing entirely.
#3: Loan approvals can be hard to come by during a recession
Lenders can choose to increase or relax their lending standards, as long as they follow federal and state regulations. During a recession, lenders face high rates of default from other borrowers. Basically they can’t afford another bad loan that doesn’t get repaid.
This means it can be tough to get approved for financing. This is true both of for personal loans and for any small business loans you may need. If you want to get approved, you’ll need a great credit score and a low debt-to-income ratio. Only the most creditworthy can get approved.
That being said, recessions can often be a great time to get new financing. The Federal Reserve typically lowers interest rates during a recession to stimulate the economy. If you have great credit and you followed the advice above, you can get really attractive rates on loans. Just make sure you have the means you cover the payments on whatever you borrow.
Originally published at www.debt.com.