How Should I Pay Down Debt During a Recession?

How Should I Pay Down Debt During a Recession? article image.

During a recession, incomes tend to dip while bills keep rolling in. If you find yourself with a reduced income during an economic downturn and debt obligations you're expected to meet, you may need to change your financial strategy to keep up.

Even when times are tough, it's best to continue making payments on your debt—and being aggressive in your paydown strategy can save you a lot of money. High-interest debt is by nature the most expensive, and tackling it first will help you get it under control and reduce how much interest you pay over time. Here's how to do it.

How to Manage Debt During a Recession

During an economic downturn, you should continue making payments on your debt obligations and bills as much as you're able to. You might prioritize paying down your credit card debt since it probably has the highest interest rates out of all your debts.

Paying down your credit card debt helps you pay less in interest charges, which can save you thousands over time. If you only ever pay the minimum on high-interest debts, a significant amount of your payment will go toward interest rather than your principal, making it difficult to pay off.

Take a few minutes to sit down and assess how much you owe in credit card debt. Write down the balance for each card as well as the card's interest rate and the monthly minimum payment. Once you have a sense of what you owe, it's easier to make an effective strategy to pay off credit card debt.

If you're able to pay off your credit card balances, you may choose to focus next on paying off loans such as student loans or an auto loan, which typically have much lower interest rates than credit cards. However, if you're not having difficulty paying these installment loans every month and you're concerned that you don't have enough in savings, it might be better to shift your focus to building up an emergency fund.

No matter how you choose to tackle your debt, make sure you're making payments on time every month, even if you can only pay the minimum. Late or missed payments can do major damage to your credit score since payment history makes up the biggest piece of your score.

What to Do if You Can't Afford to Pay Off Debt

If a recession puts you in a position where you can't afford to pay your debts, you should take action immediately to prevent some unpleasant consequences. Here are a few debt relief options to consider:

  • Work with your lender: As soon as you know you won't be able to make your next payment, contact the lender and let them know. Tell them you're struggling financially due to the recession and ask if there's anything they can do to keep your account in good standing. Some lenders and creditors are more lenient during economic downturns, and they may provide relief options such as temporarily lowering or deferring your payments.
  • Debt consolidation: Consolidating high-interest debts is a simple way to lower your interest payments, and it's something you can do yourself. One way to do this is to get a debt consolidation loan or to do a balance transfer to a credit card with a 0% APR introductory period.
  • Credit counseling: A nonprofit credit counseling agency can help you understand your debts and put together a budget. If you can't make ends meet, the agency can put you on a debt management plan where you pay the agency a monthly sum they then use to pay your lenders and creditors on your behalf. They may also be able to work with lenders to negotiate lower interest rates.
  • Debt settlement: Rather than creating a modified repayment plan like credit counselors do, debt settlement companies negotiate with your lenders to reduce the amount of debt you owe. However, these companies typically ask you to stop paying your debts while they do the negotiating, which can result in steep fees and damage to your credit. This is not a recommended option.

How to Budget and Save Money in a Recession

It's never a bad time to create a budget, but if the economy is in a recession and you're impacted personally, making a budget is an especially valuable practice. Budgets can help you live within your means, pay off debt and accomplish your financial goals.

To create a budget, you'll first add up your monthly household income. If your pay is irregular, you can use an average from the past few months.

Next, you'll tally up your monthly expenses. It's helpful to refer to your bank and credit card statements from the past few months to make sure you're looking at the complete financial picture. Group your expenses by monthly fixed (necessary) costs such as rent and utilities, and variable (discretionary) expenses, such as eating out and entertainment.

This process accomplishes a few important things. For one, it helps you see how much money is coming in and how much is going out, which can be eye-opening. If you spend more than you make, it means you're relying on debt to get by. Listing everything out can help you determine which discretionary expenses you can back or remove during a tough financial period.

If you can reduce your spending, you may be able to carve out room to put more money toward your debts (and maybe even some toward savings).

If your necessary monthly expenses (not including discretionary spending like Netflix) exceed your income and there's nothing else you can cut out, you may need to find additional sources of income to avoid accumulating more debt.

Additionally, there are ways to make money fast in a financial emergency. For example, you could take on gig work, such as grocery or meal delivery, or find people looking to hire those with your skills (such as tutoring, gardening or handiwork). You can also try selling belongings you no longer need.

How to Prepare Your Finances Before a Recession

While some recessions can hit quickly and unexpectedly, there are actions you can take ahead of time to make sure you're financially prepared for the next one.

  • Build up an emergency fund. Anytime you have extra money in your budget, throw it into a dedicated savings account. Experts recommend stashing at least three to six months' worth of living expenses so you have a fallback if you lose income or encounter an emergency. It's best to have a dedicated savings account specifically for your emergency fund so you're not tempted to use your savings. Even better: Set up direct-deposit to ensure you set aside money every month in your emergency fund.
  • Live within your means. You don't need to wait for an economic turndown to start cutting back. Even when the economy is chugging along smoothly, it's smart to stick to a budget and keep expenses low. Any remaining money can be put toward an emergency fund, retirement or debts.
  • Pay down debt. If you have any credit card debt or loans, put extra money toward your debt payments to make a bigger dent. That way, if you lose income in a recession, you'll have less debt to worry about and can make your money go further.
  • Improve your professional skills. When times are good, consider expanding your skillset. Whether it's by learning new things on the job or taking online courses and earning a certificate, professional development can make you more valuable to your employer, and more competitive in the job market.

Keep an Eye on Your Credit

While paying off debt can help you more easily weather a recession, you may find a need down the road for an emergency loan, a low-interest debt consolidation loan or even a mortgage refinance. If that happens, you'll want your credit to be in good shape to ensure you get the best possible rates and terms. Making all your payments on time and keeping credit card balances low are two of the best ways to do that. You can get a free credit score and free credit report from Experian to find out where you stand.