What is an Economic Recession?
Before you can prepare for an economic recession, it’s important to understand what a recession is. A recession is when there are two consecutive quarters of economic contraction. This is measured by a fall in gross domestic product (GDP), which results in a period of economic decline, often with an increase in unemployment, a dip in the housing market, and a dip in the housing market, and stock market losses.
Gina Gopinath, Economic Counsellor and Director of the Research Department at the International Monetary Fund (IMF), calls this time “The Great Lockdown” and wrote, “The magnitude and speed of collapse in activity that has followed is unlike anything experienced in our lifetimes.”
4 Ways to Prepare Financially for a Recession.
While the economic outlook is in flux, it’s never too late to prepare your finances so you can weather the storm. Here are 4 ways you can start recession-proofing your finances.
1. Pay down debt.
Using the next few months to pay down debt, specifically high-interest debt, can be crucial for your financial wellness. While you may not get down to zero, prioritizing what debt to pay off can help give you the breathing room you need in your budget.
- Tackle by highest interest (debt avalanche)
- Pay off the lowest balance first (debt snowball)
- Consolidate your debt with a balance transfer card, personal loan or home equity line of credit (HELOC).
Once you get a handle on your credit card debt, you can start paying down other loans that have higher interest rates, like an auto loan.
2. Build an emergency fund.
As you pay down high interest debt, it’s important to also start building up your savings so you’ll have cash available for emergencies. For instance, if you’re able to consolidate your credit card debt, the financial cushion it creates monthly in your budget could go toward your savings.
It’s important to make sure whatever you set aside doesn’t create more debt or financial stress. Start out small if you have to – every bit helps. While most financial experts recommend your emergency fund has enough to cover three-to-six months of income, the answer really depends on your budget.
3. Live within your means.
Managing your money so you live within your means is easier said than done. Experts say living within your means you spend no more than 30% of your income on things like clothes, groceries and entertainment.
This is where making a budget comes in handy. Start by cataloging every expense – rent, mortgage, car payment, groceries, entertainment – so you have an understanding of exactly where your money is going. Take it a step further by tracking every dollar you spend weekly to identify where you can make a change. You may be surprised what you discover when you break your budget down like this.
4. Keep your credit score in check.
Good credit is always important to maintain, but it’s especially important during a recession. Your credit score impacts your ability to borrow money, obtain insurance, even get a job in some states. That’s why now is a good time to figure out where your credit score stands and clear up any blemishes on your credit report.
You’re legally entitled to one free credit report every 12 months from the three main credit bureaus – Equifax, Experian and TransUnion. You can access your report by visiting AnnualCreditReport.com.
If you need to dispute a problem on your report, here are the steps to take to correct any errors.
While it’s hard to predict what will happen over the next few months, it is possible to prepare financially for an economic recession. If you’re already struggling with debt from COVID-19, here are options available for financial assistance.