Banking

Why financial experts recommend paying down debt to prepare for a recession

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While the possibility of a recession has left many Americans feeling uncertain about their finances, most financial experts agree on one key piece of advice to prepare for an economic turndown: pay down as much debt as possible.

Paying down debt is always an important step to take, but when a recession looms, doing so holds even more power than you might think.

“In general, recessions are characterized by lower economic growth and higher uncertainty. Since both of these things typically cause higher unemployment and lower income, recessions make us defensive in the way that we think about money, reducing our spending and driving us to protect our savings,” says Katherine Salisbury, co-founder of Qapital, a popular finance app. “Jobs and business income are in greater jeopardy, and we try to give ourselves greater slack so that we can be prepared for a variety of negative outcomes.”

Select asked Salisbury to weigh in on the reasons why financial experts say to pay down debt in order to prepare for a recession.

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You’ll have more credit available for tricky situations

Recessions often seem like a slippery slope since so much can be up in the air, including your employment status and how much you’ll be able to earn. If you don’t have an emergency fund — or don’t have enough money saved up in one yet — you might end up incurring more debt by turning to credit cards to pay for the things you need. That’s why it’s important to make sure you have as much money available as possible, just in case.

“Experts recommend paying down debts (and not taking on new ones) because no one wants to be caught with mounting interest payments in the event of an emergency, salary setback, or job loss,” says Salisbury. “Carrying outstanding debt means that the balance also decreases your available access to cash for future setbacks.”

The more of an available balance you have, the less likely you’ll be to max out your credit card if you do need to use it to float the costs of some expenses for a little while. In this case, your credit card would buy you some flexibility.

“Let’s say you have a $10,000 limit on you credit card and carry an $8,000 balance when your car breaks down and needs an engine overhaul,” Salisbury explains. “Mechanics are short and there are supply chain shocks overseas, where the parts are manufactured. This means that prices have gone up 20% since you bought the car. The total bill will run you $2,500 more than you expected, putting you over your credit limit.”

You could avoid having to pay higher interest rates

“Sometimes recessions coincide with rising interest rates, like the one we’re seeing now,” says Salisbury. “In that case, if you carry any debt with a variable interest rate, then you’ll see your costs increase at just the moment it hurts the most.”

If you have a personal loan with an adjustable interest rate, for example, you could be charged a higher interest rate, which means your monthly payment would increase. The same scenario is also true if you have an adjustable-rate mortgage and the fixed-rate period is about to end, or is already over.

According to the Consumer Financial Protection Bureau, credit card companies can actually increase your interest rate on new transactions as long as they provide a 45-day notice and a few other conditions are met: If your temporary interest rate has expired — if you have a credit card with a 0% intro APR offer, for instance — if you have a variable interest rate on your credit card or if your minimum payment has not been received within 60 days of its due date.

While the new higher interest rate wouldn’t apply to your existing balance, it could still make new transactions even more expensive and add to your overall debt.

You may not have to seek out other sources of credit

“Recessions also mean that access to new debt, either through bank loans or credit cards, can become scarce,” says Salisbury. “Lenders also become risk averse during lean times, just like consumers become cautious. This means that it will probably be harder to get a loan, and it will likely carry a higher interest rate if you do obtain one.”

For this reason, Salisbury asserts that it’s important to do what you can now to reduce your debt usage. Stern lenders will be more likely to approve you for new lines of credit if they see you as a more creditworthy borrower — and reducing your debt balances is an important part of this. To learn more, check out our beginner’s guide to building your credit score.

How to pay down your debt efficiently

One effective way to pay down debt faster is to use what’s known as the avalanche method, which means you’re targeting the debt with the highest interest rate first and making aggressive payments toward it while only paying the minimum for all your other debts. This particular method can help you save money on really high interest charges.

“Make a list of all of your debts, including the outstanding balance and interest rate for each,” Salisbury suggests. “Focus on one debt at a time and start by paying down high-interest debt first.”

Balance transfer credit cards with 0% intro APR periods can also be instrumental when it comes to paying off debt faster. These credit cards typically offer an initial period of 12 months or more where you won’t be charged interest on your monthly payments, allowing you to transfer an existing balance to that credit card and pay it off when no additional interest is accruing.

Select ranked the U.S. Bank Visa® Platinum Card and the Citi Simplicity® Card among the best 0% APR credit cards for both balance transfers and new purchases.

U.S. Bank Visa® Platinum Card

On U.S. Bank’s secure site

  • Rewards

  • Welcome bonus

  • Annual fee

  • Intro APR

    0% for the first 20 billing cycles on balance transfers and purchases

  • Regular APR

    15.99% – 25.99% (Variable)

  • Balance transfer fee

    Either 3% of the amount of each transfer or $5 minimum, whichever is greater

  • Foreign transaction fee

  • Credit needed

Citi Simplicity® Card

  • Rewards

  • Welcome bonus

  • Annual fee

  • Intro APR

    0% for 21 months on balance transfers; 0% for 12 months on purchases

  • Regular APR

  • Balance transfer fee

    5% of each balance transfer; $5 minimum

  • Foreign transaction fee

  • Credit needed

Lastly, Salisbury reminds us that while talk of a possible recession may be scary and even stressful when it comes to your finances, it’s okay to allow yourself to feel rewarded for all the hard work you’ve been putting in to pay down your debt.

“Leverage psychological principles, like delayed rewards, to promise yourself little treats for hitting intermediate payment milestones,” Salisbury says. “You might take yourself out for a decadent dessert or purchase a new t-shirt that you’ve been eyeing after sticking with your debt pay down plan for three months. Recessions may be lean times, but they aren’t the end of the world. We all deserve some joy and optimism, even when the economy isn’t as healthy as we’d like it to be.”

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Editorial Note: Opinions, analyses, reviews or recommendations expressed in this article are those of the Select editorial staff’s alone, and have not been reviewed, approved or otherwise endorsed by any third party.




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