Figuring out how to prepare for a recession — or any crisis — can be difficult. When facing a potential recession, financial decisions take on a new weight. After all, financial policy may change during a recession, which can leave consumers with questions. For example, if the Federal Reserve lowers interest rates, should you borrow money during a recession?
While lower recession interest rates might sound appealing, there are lots of things to consider before borrowing money during a recession.
Key Points
• Recession involves economic decline, reduced spending, and increased unemployment.
• Lower interest rates during recessions can make borrowing attractive, but risks must be considered.
• Borrowing risks include job loss and potential credit score damage.
• Borrowing may help consolidate high-interest debts or cover unexpected expenses.
• Weigh risks and benefits, consider consolidation loans, and seek professional advice.
Understanding Recessions
A recession is a period of time when economic activity significantly declines. In the U.S., the National Bureau of Economic Research defines a recession as more than a few months of significant decline across different sectors of the economy. We see this decline in changes to the gross domestic product, unemployment rates, and incomes.
In essence, a recession is a period of time when spending drops. As a result, businesses ramp down production, lay off staff, and/or close altogether, which in turn causes a continued decrease in spending.
There are many possible causes of the recession. Usually, recessions are caused by a wide variety of factors — including economic, geopolitical, and even psychological — all coinciding to create the conditions for a recession.
For example, a recession could be caused by a major disruption in oil access due to global conflict, or by the bursting of a financial bubble created by artificially depressed interest rates on home loans during a financial boom (as was partially the case with the 2008 financial crisis in the U.S.). A recession also could be caused in part by something like a pandemic, which could create supply chain disruptions, force businesses into failure, and change spending habits.
As for how psychology plays a role in recessions, financial actors might be more likely to invest in a new business or home renovation during boom years when the market seems infallible. But when an economic downturn or recession starts, gloomy economic forecasts could make people more likely to put off big purchases or financial plans out of fear. In aggregate, these psychological decisions may help control the market.
In the case of a recession, for example, many people choosing not to spend out of fear could cause a further contraction of the market, and consequently further a recession.
Financial Policy During a Recession
Economic policy might temporarily change in an effort to keep the market relatively stable amid the destabilization a recession can bring. The Federal Reserve, which controls monetary policy in the U.S., often takes steps to curb unemployment and stabilize prices during a recession.
The Federal Reserve’s first line of defense when it comes to managing a recession is often to lower interest rates. The Fed accomplishes this by lowering the interest rates for banks lending to other banks. That lowered rate then ripples throughout the rest of the financial system, culminating in reduced interest rates for businesses and individuals.
Lowering the interest rate could help to stem a recession by decreasing costs for businesses and allowing consumers to take advantage of low interest rates to buy things using credit. The increase in business and purchasing might in turn help offset a recession.
The Federal Reserve also may take other monetary policy actions in an attempt to curb a recession, like quantitative easing. Quantitative easing, also known as QE, is when the Federal Reserve creates new money and then uses that money to purchase assets like government bonds in order to stimulate the economy.
The manufacturing of new money under QE may help to fight deflation because the increase in available money lowers the value of the dollar. Additionally, QE can push interest rates down because federal purchasing of securities lowers the risks to lending institutions. Lower risks can translate to lower rates.
Recommended: Federal Reserve Interest Rates, Explained
Downsides to Borrowing Money During a Recession
How do you prepare for a recession? It might seem smart to borrow during this time, thanks to those sweet recession interest rates. But there are other considerations that are important when deciding whether borrowing during a recession is the right move. Keep in mind the following potential downsides:
• There’s a heightened risk of borrowing during a recession thanks to other difficult financial conditions. Disruptive financial conditions like furloughs or layoffs could make it more difficult to make monthly payments on loans. After all, regular monthly expenses don’t go away during a recession, so borrowers could be in a tough position if they take on a new loan and then are unable to make payments after losing a job. Missed payments could negatively impact a borrower’s credit score and their ability to borrow in the future.
• It may be harder to find a bank willing to lend during a recession. Lower interest rates may mean that a bank or lending institution isn’t able to make as much money from loans. This may make lending institutions more hesitant.
• Lenders could be reluctant to lend to borrowers who may be unable to pay due to changes in the economy. Most forms of borrowing require borrowers to meet certain personal loan requirements in order to take out a loan. If a borrower’s financial situation is more unstable due to a recession, lenders may be less willing to lend.
When to Consider Borrowing During a Recession
Of course, there are still situations where borrowing during a recession might make sense. If you’re hit with unexpected expenses or have the opportunity to buy quality stocks for a lower price, for instance, it could make sense to have extra funds available.
Another scenario where it might be a good idea is if you’re consolidating other debts with a consolidation loan.
If you already have debt, perhaps from credit cards or personal loans, you may be able to consolidate your debt into a new loan with a lower interest rate, thanks to the changes in the Fed’s interest rates. Consolidation is a type of borrowing that doesn’t necessarily increase the total amount of money you owe. Rather, it’s the process by which a borrower takes out a new loan — with hopefully better interest rates and repayment terms — in order to pay off the prior debts.
Why trade out one type of debt for another? Credit cards, for example, often have high interest rates. So if a borrower has multiple credit card debts with high interest rates, they may be able to refinance credit card debt with a consolidation loan with a lower interest rate. Trading in higher interest rates loans for a consolidation loan with potentially better terms could save borrowers money over the life of the loan. It also streamlines bill paying.
When considering consolidation, borrowers may want to focus on consolidating only high-interest loans or comparing the interest rates between their current debts and a potential consolidation loan.
Note that interest rates on consolidation loans can be either fixed or variable. A fixed rate means a borrower may be able to lock in a lower interest rate during a recession. With a variable interest rate, the loan’s interest rate could go up as rates rise following a recession.
Additionally, just like many other types of loans, consolidation loans require that borrowers meet certain requirements. Available interest rates may depend on factors like credit score, income, and creditworthiness.
Recommended: How to Apply for a Personal Loan
The Takeaway
It can be challenging to navigate any economic downturn, and it’s natural to wonder how to prep for a recession. Deciding whether to borrow, including taking out a personal loan, is a decision that depends on your specific circumstances. There are downsides to consider, such as the general economic uncertainty that can increase risk and heightened risk-aversion from lenders. But if you have high-interest debt, or can secure a lower rate by consolidating, then taking out a consolidation loan during a recession could make sense. It’s a good idea to weigh the risks and benefits carefully and seek out professional advice before making a decision.
Think twice before turning to high-interest credit cards. Consider a SoFi personal loan instead. SoFi offers competitive fixed rates and same-day funding. Checking your rate takes just a minute.
FAQ
Is it good to have money in the bank during a recession?
The general consensus is that banks are a safe place to keep your cash during a recession. If your account is insured by the Federal Deposit Insurance Corporation (FDIC), then individual deposits up to $250,000 are protected. Banks also protect funds against theft or loss.
Is it better to have cash in a recession?
It’s a good idea to have some of your money in cash during a recession. That’s because if you’re laid off from your job or an emergency arises, it can be helpful to have a cushion of readily accessible money.
Should I withdraw all my money during a recession?
If you’re thinking about how to prepare for the recession, it can be tempting to want to take out all of your money from a bank. But there’s good reason to reconsider. Many banks are FDIC insured, which means deposits up to $250,000 are protected.
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