Should You Borrow Money in a Recession?
It seems like personal finances can take a nose dive these days, but this is especially true during a recession.
When times are tough and money is tight, consumers are left searching for ways to get a bit more income.
It’s been over a decade since the biggest economic shock around the Great Recession. Did you know that the recession we went through in the US between December 2007 and June 2009 was the worst economic downturn since the Great Depression of the 1930s?
It had a knock-on effect on everyone–wages fell behind inflation for years and savers experienced one of the worst returns in the country’s history.
In times of economic stress, the Federal Reserve lowers interest rates. The sweet recession interest rates might sound appealing to many, but should you borrow money during a recession? Let’s find out!
What is a Recession?
A country’s economy and its performance are measured using the GDP.
GDP is calculated by summing up the total amount of goods, and services sold during one year.
According to the National Bureau of Economic Research, a recession is a period of economic downturn characterized by a decline in GDP that lasts for more than a few months, typically two or more consecutive quarters.
It’s marked by a decline in overall economic growth and activity, including increased unemployment, reduced industrial production, a decline in stock prices, and other financial indicators.
Natural disasters, global events such as war or pandemics, and changes in monetary policies can causes recessions. Internal economic factors can also cause them such as a slowdown in the housing market, a decline in consumer spending, or business failures.
Recessions can severely impact individuals, businesses, and entire economies and take a while to recover.
What’s Borrowing Money during a Recession Like?
You’ll find it harder to borrow money from banks and other lenders during a recession. Worry not–everyone does, so it’s nothing personal to you.
There’ll be a few options out there, but they’ll be harder to find.
Lenders have a “borrower profile”–which basically means their target customers. They feel more comfortable lending money to customers whose financial and personal circumstances most closely match their borrower profile.
The reason securing a personal loan can be much more difficult during a recession is that the odds of borrowers defaulting on their loans because of financial hardships go up when the economy struggles.
You’ll have better chances of securing a loan when you understand what criteria lenders used to determine your creditworthiness.
Why Do Banks Cut Back on Borrowing During Recessions?
When you approach a bank, credit union, or any other lender because you want to borrow money, they’ll get the money they lend you from one of two places:
When a recession happens, these institutions get nervous and stop funding until they’re convinced that the lender is stable enough.
It’s not that banks don’t want to lend money. Because they no longer have money to lend out, they cannot make as many loans as they could before, so they are cautious about the people they lend money to.
That said, getting approved for a personal loan during a recession isn’t impossible. Working on improving your credit score and lowering your debt-to-income ratio can help you secure a loan.
What Interest Rate Will You Get During A Recession?
Interest rates vary based on various factors, including employment, income, credit score, assets, and debts.
However, with economic volatility, lenders boost interest rates for loans.
The Fed reserve lowers the Federal Funds Rate to spur economic growth. This is the rate at which banks lend money to one another.
When the federal funds rate drops, lenders typically adjust interest rates for loans, meaning borrowing becomes less expensive to borrowers.
Should I Borrow During A Recession?
Whether you should borrow money during a recession depends on your unique circumstances and the purpose of the loan.
It’s best to avoid taking on additional debt during a recession if you can, as periods of economic volatility can make it more difficult to find and keep a job because of layoffs and furloughs, which can make it harder to repay loans.
It may be necessary for you if need to borrow money to cover essential expenses, such as home repairs or medical bills.
“If you’re in a stable job and can secure a low-interest loan, it may be a good chance to invest in something that will appreciate in value over time,” says Robert Cavanagh, Senior Vice President of Investments, at David Lerner Associates.
Conclusion
It’s vital to consider the benefits and risks of borrowing money during a recession before deciding.
- Savers who have deposited money with them
- Institutions that manage money on behalf of others (hedge funds, pension funds, etc.)
IMPORTANT DISCLOSURES
Material contained in this article is provided for information purposes only and is not intended to be used in connection with the evaluation of any investments offered by David Lerner Associates, Inc.
This material does not constitute an offer or recommendation to buy or sell securities and should not be considered in connection with the purchase or sale of securities.
To the extent that this material concerns tax matters, it is not intended or written to be used, and cannot be used, by a taxpayer for the purpose of avoiding penalties that may be imposed by law. Each taxpayer should seek independent advice from a tax professional based on his or her individual circumstances.
These materials are provided for general information and educational purposes based upon publicly available information from sources believed to be reliable– we cannot assure the accuracy or completeness of these materials. The information in these materials may change at any time and without notice.
David Lerner Associates does not provide tax or legal advice. The information presented here is not specific to any individual’s personal circumstances.