4 Factors to Consider if You Want to Borrow Money During a Recession

By Chika

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Last Updated: December 12, 2022

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It can be challenging to handle money during a recession - or any other crisis.

Financial choices are more important when there is a chance of a recession. After all, during a recession, financial policy may alter, which may leave consumers with questions.

For instance, should you borrow money in a downturn if the Federal Reserve cuts interest rates?

Although reduced interest rates during a recession may seem enticing, there are several factors to take into account when borrowing money. In this article we look at some factors which should influence your borrowing decisions during a recession. 

 

 

4 Factors That Can Influence Your Borrowing During a Recession

1. Understanding Recessions

When economic activity slows dramatically, it is said to be in a recession.

According to the National Bureau of Economic Research, a recession in the United States lasts longer than a few months and is characterized by a considerable fall in all economic sectors. 

A common definition of recession is two consecutive quarters of negative economic growth. This decline is characterized by changes in the gross domestic product, unemployment rates, and incomes.

During a recession, consumer spending declines. As a result, companies scale back their operations, fire employees, or even go out of business entirely, which further reduces consumer spending and limits the amount of money circulating in an economy.

The recession could have a variety of causes. Recessions are typically brought on by a number of interrelated variables, including economic, geopolitical, and even psychological ones that all work together to foster the right conditions for one.

 

2. Recession and Monetary Policy

In an effort to maintain the market largely stable amid the disruption that a recession can bring, economic policy may change for a while.

During a recession, the Federal Reserve, which oversees monetary policy in the U.S., frequently takes action to try and reduce unemployment and stabilize prices.

Lowering interest rates is frequently the Federal Reserve's first line of defense in controlling a recession. The Fed achieves this by reducing the interest rates charged by banks to other banks for lending.

The financial system as a whole is subsequently affected by that decreased rate, which ultimately results in decreased interest rates for both firms and consumers.

By reducing expenses for businesses and enabling consumers to benefit from low interest rates to purchase goods on credit, lowering the interest rate could help to stop a recession. A recession can be tempered by the uptick in commerce and spending.

In an effort to stop a recession, the Federal Reserve may also implement other monetary policy measures, such as quantitative easing.

Quantitative easing, or QE as it is more often known, is the process through which the Federal Reserve prints additional money and uses it to buy assets like government bonds in an effort to boost the economy.

Because the creation of more money under quantitative easing (QE) reduces the value of the dollar, it may aid in the fight against deflation.

Additionally, because the federal government's purchase of securities reduces the risks to lending institutions, QE can cut interest rates. Lower rates may result from lower hazards.

 

3. How Psychology Reinforces Recession

Psychology or sentiment plays a role in reinforcing recessions.

For example, people are more prone to making investments in a new company or home remodeling during peak times when the market appears to be unfailing. 

However, pessimistic economic predictions may increase people's propensity to postpone major purchases or financial plans out of anxiety when an economic downturn or recession begins. Collectively, these psychological choices might aid in sentiment towards the economy.

For instance, if there is a recession, many people may decide to refrain from spending out of fear, which could deepen the recession by causing the market to contract.

 

4. Downsides to Borrowing Money During a Recession

Even while taking out a loan during a recession could seem like a good idea because of the attractive interest rates, there are other factors to take into account before doing so. Consider the following possible drawbacks of borrowing during a recession:

  • Due to other challenging financial circumstances, borrowing during a recession carries a higher risk. Making loan payments on time may be more challenging in the event of tough financial circumstances like layoffs or furloughs. Since regular monthly obligations continue to exist even during a recession, borrowers may find themselves in a difficult situation if they take out a new loan only to find themselves unable to make payments after losing their jobs.
  • During a recession, it could be more difficult to find a bank that will lend. A bank or other lending organization may find it more difficult to profit from loans when interest rates are lower. Lending institutions can become less confident as a result.
  • Due to changes in the economy, lenders could be hesitant to lend to borrowers who might be unable to pay back the loan. In order to obtain a loan, borrowers must typically fulfill specific standards for personal loans. Lenders might be less likely to lend if a borrower's financial status becomes more insecure as a result of a recession.

 

 

When to Borrow in a Recession

Of course, there are still circumstances in which taking out a loan during a recession makes sense.

If you're using a consolidation loan to combine other debts, borrowing during a recession can make sense in that case.

Due to changes in the Fed's interest rates, if you already have debt—perhaps from credit cards or personal loans—you might be able to consolidate it into a new loan with a reduced interest rate.

Consolidation

Consolidation is a sort of borrowing that doesn't always result in a rise in your overall debt. Instead, it refers to the procedure through which a borrower obtains a new loan to pay off the previous underlying debts, with ideally better interest rates and payback terms.

Why would one debt kind be exchanged for another?

For instance, interest rates on credit cards are frequently high. A borrower may be able to refinance credit card debt with a consolidation loan at a lower interest rate if they have several high-interest credit card obligations.

Over the course of the loan, consumers may save money by switching from loans with higher interest rates to consolidation loans with possibly better terms.

It could be simpler to manage a single monthly payment for one loan as opposed to numerous. A borrower typically has to take into account a range of various payment due dates, interest rates, and outstanding balances when paying off a variety of credit cards.

Additionally, compounding interest starts to accrue if the entire credit card balance is not paid in full by the end of the billing cycle, raising the total amount due.

Compare Interest Rates

Borrowers who are thinking about merging their debts may wish to compare the interest rates on their current debts and any potential consolidation loans, or they may choose to concentrate on consolidating only high-interest loans. 

Moreover, keep in mind that the interest rates on loans for consolidation can be either fixed or variable.

A borrower may be able to lock in a cheaper interest rate during a recession if the loan has a fixed rate. If the loan had a variable interest rate, the interest rate might increase when the cost of borrowing increased after a recession.

Consolidation loans also have conditions that borrowers must meet, just like many other loan types. Interest rates may vary based on variables like creditworthiness, income, and credit score.

 

 

The Takeaway

Your unique situation will determine whether you decide to borrow money during a recession, including whether or not you take out a personal loan.

There are drawbacks to take into account. One of such as the elevated level of uncertainty from lenders and the broader economic unpredictability that can raise risk. However, taking out a consolidation loan during a recession can make sense if you have high-interest debt or could get a better rate by consolidating.

Photo by Pavel Danilyuk

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