Why Financial Experts Suggest Paying Off Debt Before a Recession

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While the possibility of a recession has left many Americans uncertain about their finances, most financial experts agree on one key piece of advice for preparing for an economic downturn: Pay off as much debt as possible.

Paying off debt is always a big step to take, but when a recession looms, it has even more power than you think.

“In general, recessions are characterized by lower economic growth and higher uncertainty. Since these two factors usually lead to higher unemployment and lower incomes, recessions make us defensive in how we think about economics. money, reducing our expenses and pushing us to protect our savings,” says Katherine Salisbury, co-founder of Qapital, a popular financial app. “Jobs and business incomes are at greater risk, and we’re trying to give ourselves more leeway so that we can prepare for a variety of negative outcomes.”

Select asked Salisbury to look into why financial experts say to pay down debt in order to prepare for a recession.

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You will have more credit available for delicate situations

Recessions often feel like a slippery slope because so many things can be up in the air, including your employment status and how much you will be able to earn. If you don’t have emergency fund — or if you don’t have enough money set aside yet — you could end up taking on 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 cash as possible, just in case.

“Experts recommend paying off debt (and not taking on new ones) because no one wants to be stuck with mounting interest payments in the event of an emergency, lower salary or job loss,” says Salisbury. “Having an unpaid debt means the balance also decreases your available access to money for future setbacks.”

The more balance you have available, the less likely you are to max out your credit card if you need to use it to float the costs of certain expenses for a little while. In this case, your credit card would give you some flexibility.

“Let’s say you have an $10,000 limit on your credit card and you have an $8,000 balance when your car breaks down and requires an engine overhaul,” says Salisbury. “The mechanics are short and there are shocks in the supply chain overseas, where the parts are made. That means prices have gone up 20% since you bought the car. The total bill you will cost $2,500 more than expected, putting you over your credit limit.”

You could avoid having to pay higher interest rates

“Sometimes recessions coincide with a rise in interest rates, like the one we’re seeing right now,” says Salisbury. “In this case, if you have variable interest rate debt, you’ll see your costs go up just when it hurts the most.”

If you have a adjustable interest rate personal loan, for example, you might be charged a higher interest rate, which means that 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 has already ended.

According to the Consumer Financial Protection Bureau, credit card companies can actually raise your interest rate on new transactions as long as they provide 45 days notice and a few other conditions are met: If your interest rate term has expired – if you have a credit card with a 0% APR introductory offer, for example – 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 won’t apply to your existing balance, it could still make new transactions even more expensive and increase your overall debt.

You may not have to look for other sources of credit

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

For this reason, Salisbury says it’s important to do what you can now to reduce your use of debt. Harsh 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 that. To learn more, see our beginner’s guide to establishing your credit score.

How to repay debt effectively

An effective way to pay off debt faster is to use what is called avalanche method, which means you target the debt with the highest interest rate first and make aggressive payments while only paying the minimum on all your other debts. This particular method can help you save money on very high interest charges.

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

Balance transfer credit cards with 0% APR intro periods can also be useful for paying off debt faster. These credit cards generally offer an initial period of 12 months or more during which you will not be charged interest on your monthly payments, allowing you to transfer an existing balance on this credit card and pay it off when no additional interest does not accumulate.

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Citi Simplicity® Card

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Finally, Salisbury reminds us that while talking about a possible recession can 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 put in to pay off your debt. .

“Take advantage of psychological principles, like delayed rewards, to promise yourself little treats for reaching intermediate payment milestones,” says Salisbury. “You could go out for a decadent dessert or buy a new t-shirt that you ogled after sticking to your debt repayment plan for three months. Recessions can be lean times, but they’re not the end We all deserve a bit of joy and optimism, even when the economy isn’t as healthy as we’d like.

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Editorial note: Any opinions, analyses, criticisms or recommendations expressed in this article are those of Select’s editorial staff only and have not been reviewed, endorsed or otherwise endorsed by any third party.