5 Ways to Prepare for a Recession
Reading time: 7 minutes
- A recession is a period of economic downturn spread across several months or years.
- To help prepare for a recession, job loss or other financial hurdle, aim to build an emergency fund that covers three to six months of living expenses.
- If you're falling behind in debt payments, reach out to your creditors and ask for hardship concessions.
What is a recession?
A recession occurs when a region's economy declines over several months or even years. During these periods, the region's gross domestic product (GDP), or the total value of the goods and services it produces, drops. At the same time, dramatic changes may occur in the price of commodities like oil or gas. Previously profitable industries may suddenly become less valuable. Consumers may see increased inflation or higher-than-normal levels of unemployment. As a result, consumer confidence also suffers, meaning that people may be less willing to spend money than they would usually.
In 2008, for example, Americans experienced a significant recession following the sudden collapse of the U.S. housing market. More recently, the COVID-19/Coronavirus pandemic caused major losses in daily business and employment across multiple industries including, hospitality, retail and tourism. As a result, the U.S. faced a short recession during the early months of 2020.
What happens in a recession?
During periods of recession, companies make fewer sales, and economic growth stalls or becomes nonexistent.
To cut rising costs, organizations may be forced to lay off large portions of their staff, resulting in widespread unemployment. At the same time, hiring slows down, making it difficult for the newly unemployed to find another job.
Investments like stocks and real estate tend to lose money, meaning that retirement and other savings accounts can suffer. Lenders may also respond to the increased financial uncertainty by raising their lending requirements, making it much more difficult for people to qualify for new credit accounts.
Recessions are an unavoidable part of any economy. But you can weather the storm by anticipating challenges early and preparing for the future. With that in mind, here are five essential steps to help you plan for uncertain times.
- Take stock of your financial priorities
One of the hardest parts of a recession is not knowing what comes next, and when things will get better. That's why it's important to be clear about where you stand financially. Ask yourself these key questions as you take stock of your financial situation.
- How much cash do I have on hand?
- How much cash can I get my hands on quickly, if I need it?
- How much debt do I currently have (credit cards, student loans, etc.)?
- What are my basic monthly living expenses, including food, shelter, health insurance, transportation and childcare?
- Do you have any major life events coming up with significant expenses attached (for example, weddings, a baby or retirement)?
Now is the time to understand what you're spending today and to anticipate your needs over the next six months. If you're well-prepared for a recession, a job loss or other financial hurdle, you'll have an emergency fund that covers three to six months of living expenses (and hopefully a healthy nest egg for retirement).
If you don't have at least three to six months of basic expenses in cash, then set that as your financial goal. Start by developing a basic understanding of how you are spending your money and building a budget.
To start building a budget, figure out your total household income from all sources, including you, your spouse/partner and any side hustles that bring cash into the household. You should also include income from investments and any other sources, such as child support.
Next, list your monthly expenses, including your rent or mortgage payments, utilities, groceries, pharmaceutical and medical needs, childcare costs, home and auto maintenance, debt payments and insurance premiums, as well as any other regular expenses, including those you only pay annually. Add everything up to understand whether you're spending more, less or roughly the same as your take-home pay each month.
Finally, prioritize your essential expenses and make sure you identify the minimum you can spend in a given month to get by — just in case you or your spouse/partner experiences a job loss.
Your budget may need to adapt in preparation for a recession, and that's okay. Try to cut down on non-essential spendings, like entertainment, cable and clothing. While it's unrealistic to think you can cut out all discretionary spending, it's important to separate wants and needs. Look for areas where you may have overspent. Try to figure out why that happened. You might not have extra money right now to put toward your retirement or a down payment, which is all right for the short term.
Once you get in the habit of reviewing your finances and looking for problem areas, you're off to a great start.
- Focus on debt repayment if you're able
You might be worried about paying off outstanding debts in the coming months, like credit card bills, utilities or student loans. If you experience a loss of income, you might have to forego paying one or more of these bills, so it's important to understand which bills you need to pay.
After all, if you lose income, you may not be able to pay every bill on time or in full every month. And, that will have a direct impact on your credit scores.
Normally it's important to do whatever you can to keep your credit scores intact, but during a recession that may not be possible. Therefore, you should prioritize how you pay your bills, so your available cash covers as many debts as you're able.
- Make sure you pay your rent or mortgage on time and in full. You don't want to face foreclosure or eviction.
- Make your car payment, especially if you need a car to get to work.
- If you're facing an income reduction, contact your student debt lender and ask for a hardship application, which may buy you a few months where you don't have to make a payment.
- Make at least your minimum payment on your credit card. If that's not possible, contact your credit card company and try to work out a payment plan. (Just know that the creditor will likely freeze your accounts, which will prohibit you from making additional purchases with the card.)
- Continue to keep up with your medical debts if you can, however, do so after other debts are met first. If your health insurance is offered through your employer, you will continue to receive health insurance coverage even if your medical bills mount. If you buy your own health insurance, whether you're self-employed or for any other reason, be sure you pay your premium on time so your policy isn't canceled.
Remember, if you're falling behind, reach out to your creditors and ask for hardship concessions. This might include making interest-only payments on your debt or putting payments into forbearance.
You can also check out your local bank or credit union for a personal loan. There are online lenders as well, and your employer may offer a short-term loan program in times of trouble.
If you're making your payments on time, you can also ask your credit card company or any other lender about lowering your interest rates. A significant number of major utility providers offer programs that might allow you to pay your bills at a later date or provide other hardship assistance. You'll never know what agreement you and your creditor can reach if you don't ask.
- Consider your career opportunities, both now and in the future
Recessions often result in high levels of unemployment. So, it's important to consider how tough economic times could affect your career and have a backup plan should you face a layoff.
Start by refreshing connections within your professional network. Be sure to consider not only your coworkers but also any connections you have outside of your current employer. Having established relationships at a variety of organizations can give you a huge leg up in the job market. You might consider reaching out to your network via social media or offering to meet up in person for coffee.
It may also help to update your resume and other job-hunting tools ahead of time. As you review your past work experience, look for any gaps. Are there places where you could pursue continuing education or additional training? Expanding your skill set is one of the best ways to invest in yourself as an employee. This is true even if you're able to keep your position during a recession.
For some workers worried about a layoff, it may be beneficial to pick up a side gig such as freelancing or working for a rideshare application. Having an extra stream of income can not only help in the event of a layoff but can make it easier to build your emergency savings while you're still employed.
- Try to bolster your emergency fund ahead of time.
Even if job cuts or layoffs are looming, put as much cash into your emergency fund as possible. You'll need every bit of it when the income stops flowing. Give up all the extras, including takeout and delivery.
While tapping into your emergency fund is never a decision you should make lightly, losing a job or being forced to live on a reduced salary certainly qualifies as a good reason to use some of the cash you've put away. However, it's important to rebuild your emergency fund as soon as your financial situation is more stable. Otherwise, when the next emergency hits, you might have to make tough decisions, like withdrawing money from your retirement account or applying for a home equity line of credit.
- Make an effort to stay on top of your financial situation
A recession may be an uncertain time, but the best thing you can do is take proactive steps now to prepare yourself. To help you stay on top of your finances in these stressful times, you can trust Equifax for reliable information on need-to-know topics. Now more than ever, financial education is important, so you can feel good about where you are with your money, regardless of any challenges ahead.