How to Prepare for a Recession

Recessions occur when growth stops and the economy starts to shrink. They're inevitable, but unpredictable. And you can take steps to better prepare your finances.

NerdWalletMarch 31, 2020
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The coronavirus pandemic began as a public health concern, but it wasn’t long before the fallout from the spreading outbreak began to raise troubling economic questions. Perhaps chief among them: Will this lead the world into an economic recession?

Understanding recessions

A recession occurs when economic growth stops and the economy starts to shrink. Recessions are inevitable, but they aren’t necessarily predictable. It’s impossible to know in advance exactly when they’ll hit or how bad they’ll get.

Some recessions are mild. Economic activity declines and unemployment rises, but the economy quickly recovers. Other recessions, such as the 18-month 2007-to-2009 downturn often referred to as the Great Recession, wreak widespread havoc on millions of people’s financial lives before economic growth resumes. And that downturn would be followed by more than a decade of economic growth.

You can’t control what happens to the wider economy, but you can take a few steps to help you survive the financial headwinds.

Start with a spending plan

If you’ve never had a budget — or have one you never consult — take another run at making one. Knowing where your money is going helps you prepare for and adjust to tough times.

This is particularly true if you’re expecting a decline in income, whether from a job loss or another factor. If a recession interferes with your ability to cover your expenses, your first step may be to pay bills strategically and know where to find assistance.

If you are able to meet expenses but still want to improve your financial footing, the 50-30-20 budget is a solid choice to assign dollars to needs, wants and savings or debt payoff. Using online tools to track your spending or a budget worksheet can help you remember to include expenses that don’t happen every month, such as car maintenance.

Once you know where your dollars are going, look for places to trim. Finding ways to save money can help you bulk up that emergency fund (more on that below) or proactively lower your debt load.

Also, consider ways to make extra money. A side hustle not only feeds your emergency fund and financial resilience, but it also gives you a Plan B to help out if your hours or wages are cut.

Not about spending, but still important to consider early: If your field of employment is vulnerable to a recession but you’ve not yet been laid off, keep your resume updated and be diligent about networking. It’s wise to have a game plan to handle job loss to help you through the immediate aftermath.

Bolster your savings

Start with the savings you have now and try to build it as much as possible. That can be difficult in the face of a drop in income, but if you’re able to save even a little each month, that cushion will likely come in handy down the road.

If you do have some savings, one step you can take today is to switch to a high-yield savings account. Recent Federal Reserve rate cuts have led to banks lower their yields, but there are still some accounts, particularly at online banks, that earn rates north of 1.50% APY.  Compare that to the average savings rate of 0.09% APY.

You can build your savings account balance over the next few months by setting up or increasing an automatic transfer on a regular basis, such as on each payday.

From there you can build your account balance over the next few months by setting up or increasing an automatic transfer from checking to savings on a regular basis, such as on each payday. Saving your tax refund and any other windfalls also could go a long way toward preparing an emergency fund.

In addition, make sure you’re not paying monthly fees. Some banks will waive surcharges if you keep a minimum balance amount. But if you’re concerned about paying monthly fees in the future, consider putting your money in a “free” account that does not charge them at all.

» Looking for online savings options with good rates and low fees? Check out NerdWallet’s best high-yield online savings accounts.

Curate your credit

High-interest debt — like credit card debt — can be especially difficult to shed when money is tight. Interest charges pile up quickly, and if you’re making only the minimum payment while adding new charges to the balance, the debt can quickly balloon and become unmanageable.

Get ahead of the curve by moving your high-interest debt to a card with an introductory 0% APR offer on balance transfers. You’ll generally need good or excellent credit (credit scores of 690 and higher) to qualify for such an offer, and in most cases, you’ll have to pay a balance-transfer fee of 3% to 5% of the amount transferred. But such a move could save you a bundle in interest charges, particularly if you can pay off the debt during the promotional period.

If you can’t qualify for one of these offers, making extra payments on high-interest debt instead is also a good money-saving option. The faster you can pay off those balances, the more you’ll save in interest charges.

Take care of your credit. If hard times come, having good credit can not only give you the option to borrow money but it also can get you the best terms, such as low interest rates on loans or 0% APR offers on credit cards.

Also, take care of your credit. In unpredictable times, you may need to lean on credit — for example, to cover expenses when your hours are cut, or to pay for costly, unexpected bills. If hard times come, having good credit can not only give you the option to borrow money but it also can get you the best terms, such as low interest rates on loans or 0% APR offers on credit cards.

Double down on good credit habits, if you have the resources to do so while meeting all your other financial obligations. Pay bills on time. Stay well below the limit on your credit card if you can. Make a debt payoff plan. Be selective about applying for new lines of credit.

All the while, keep tabs on your credit score. You can do this for free on NerdWallet, with credit card issuers and banks or through other third-party websites.

Study your student loan strategy

Federal student loan payments are now automatically suspended — without incurring interest — until September 30. Eligible loans are federal direct loans, parent PLUS and graduate PLUS loans, as well as federally held FFEL or Federal Family Education Loans and Perkins loans. The policy does not apply to private student loans.

At worst, you pay off your loans six months later than planned, and you can divert cash to other, more urgent needs.

If you can afford your student loan payment, consider continuing to making payments. You'll chip away at your principal balance even more quickly while new interest is suspended. Contact your servicer to make payments. But if you experience a significant financial change — like a job loss — you have a few options to ease the burden of your federal student loans once the payment waiver period ends:

  • Get on a new repayment plan. Income-driven repayment caps payments at a portion of your discretionary income — between 10% and 20% — and forgives your balance after 20 or 25 years of payments. Submit an application at studentaid.gov. This is your best long-term solution.

  • Request a pause on payments. Forbearance is best for temporary relief. Retroactive to March 13, all federally held student loans are automatically placed in a six-month forbearance. While payments are paused, during this interest waiver period, interest will not accrue.

  • Find out if you qualify for deferment. If you’re underemployed or unemployed for a longer period of time, then contact your servicer about unemployment deferment or economic hardship deferment. If you qualify, you could defer loans for up to 36 months. Interest will accrue on unsubsidized loans once the interest waiver period ends.

If you have private loans, contact your lender about options for relief. Most private lenders offer forbearance or deferment up to 12 months or longer. Interest will continue to accrue.

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On the other hand, if you don’t anticipate taking a hit financially during a recession, then you can take advantage of low interest rates by refinancing your loans. That means trading out your current student loans for a new one with a lower interest rate.

You can refinance federal student loans, but you lose out on income-driven repayment and opportunities for forgiveness like Public Service Loan Forgiveness.

Keep calm and invest on

This isn’t the easiest advice when the news is dominated by falling stock prices. But there is a bright silver lining to market downturns: Your regular investing contributions now purchase more stocks and fund shares than when the market was at record highs.

It’s natural to want to sell during market drops. Behavioral economists call it “loss aversion.” Studies suggest people feel the loss of $1 twice as much as a $1 gain. This instinct means they have a tendency to sell stocks when a buy-and-hold strategy would be smarter.

When you sell shares as prices are falling, you lock in losses. Studies show that even professional investors usually fail when trying to time the market (predicting when to buy low and sell high). Instead, patience and regular reinvestment through dollar-cost averaging pay when you’re investing for the long term.

When you sell shares as prices are falling, you lock in losses. Instead, patience pays when you’re investing for the long term.

As our market crash calculator shows, even after the 2007-2009 Great Recession — the biggest downturn since the Great Depression — the S&P 500 regained its previous high five years and five months after hitting bottom. And then continued to rise for nearly seven more years.

A time-tested tactic: If you’re investing for the long term with a diversified portfolio, don’t torment yourself by checking your portfolio value every day. Instead, remember your long-term goals and the market’s historical ability to rise from the ashes (and beyond) over time.

And if you've not been saving before now? It's still a good idea to begin devoting what you can to retirement savings.

Reconsider your real estate

If you’re a renter, start reducing expenses so you'll have money saved to pay the rent if your income is interrupted. Consider getting a roommate (or another roommate, if you already have one) and look for other ways to save money.

If you’re a homeowner or want to be, your game plan varies based on whether you want to buy, sell or stay put.

If you plan to buy a home this year or next, have realistic expectations about what you can afford and make sure you have a financial cushion to protect you in the months after you buy. That means knowing what you can afford and bulking up your reserve savings. To avoid buying too much home, use NerdWallet's home affordability calculator and choose a price in the "affordable" range, not in the "stretching" or "aggressive" ranges.

When you buy a home, the lender may scrutinize your finances to make sure you'll have some money in savings even after you close on the home. If you're buying a single-family home as your primary residence, the lender might require you to have up to six months' worth of house payments in savings. Save up more than the minimum required reserves, so you'll be able to afford an emergency repair or an interruption in income.

You may be able to reduce expenses by refinancing your mortgage at a lower interest rate. Recessions often are accompanied by falling mortgage rates, giving homeowners a refinance opportunity.

If you plan to sell your home this year or next, don’t rush to market. While the last recession in 2007 to 2009 cratered home values nationwide, the next recession may not. (Remember, the Great Recession began in the housing finance system.) It's possible that values will fall modestly, but it's also possible that they won't fall at all. In all but expensive price ranges, potential buyers have outnumbered sellers for years, and year-over-year home prices have gone up for about eight straight years.

If you’re planning to stay put, you may be able to reduce expenses by refinancing your mortgage at a lower interest rate. Recessions often are accompanied by falling mortgage rates, giving homeowners a refinance opportunity. When rates plummet in a short time, lenders get more refinance applications than they can handle and raise rates to manage their workloads. In these cases, it pays to patiently and persistently keep track of refinance rates. After lenders process the first wave of refinance applications, they might drop rates again.

Whether or not you refinance, build up your savings to protect yourself from an interruption in income. NerdWallet's guideline is to save three to six months' worth of expenses.

Finally, a home equity line of credit, or HELOC, can be used as a last-resort emergency fund. Apply for a HELOC while you still have steady income; otherwise, you won't qualify.

Keep perspective

There are many things you can't control in life, and recessions are among them. What you can control is how you react to such events. It's tough to stay relaxed in the face of things like job loss and unpaid bills. But it's also difficult to think clearly when your stress levels are high, and thinking clearly is a key part of navigating any financial challenge.

If you find yourself struggling to manage financial stress, you're not alone. Fortunately, there are ways to cope. One tactic is to remind yourself that many of the most important things in life have little to do with money, including your health and your connections to family and friends. Taking opportunities to nurture and appreciate those things can help put financial challenges into perspective.

Staff writers Margarette Burnette, Anna Helhoski, Holden Lewis, Bev O'Shea, Claire Tsosie, Kevin Voigt and Liz Weston contributed to this report.

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