Before the COVID-19 pandemic hit in 2020, I asked you all a question: If the economy went belly up, would you be prepared? What if World War III happened? I asked this after 2019, a year that saw incredible returns. I had a feeling something bad was on the horizon, and boy, was I right! Let’s revisit that post and see how things played out.
The U.S. was enjoying its longest economic expansion in history. But when the Federal Reserve starts cutting interest rates, it’s usually a sign that the economy is slowing down, or worse. After hiking rates nine times from 2015-18, the Fed did a U-turn this year, slashing the short-term federal funds rate three times.
Another worrying trend was the rising unemployment rate among recent college graduates, suggesting employers were nervous about growth. Booms and busts are part and parcel of our free-market, capitalist system, which has weathered seven recessions since the 1970s. It’s clear that growth is slowing worldwide.
Most people felt a recession was looming. In a recent poll, nearly two-thirds of Americans said they think a recession is likely next year. Almost half of those who see a storm brewing are preparing for it by cutting back on spending and paying down debt.
Rate cuts are meant to encourage people to borrow and spend. But this time, it seems like American households have learned their lesson, even if Washington hasn’t. The downturn arrived in 2020 due to the coronavirus pandemic, sooner than most of us expected. This makes the advice in this post more important than ever.
It’s always wise to manage any debt you have, whether it’s credit card balances, student loans, or a mortgage. If the economy tanks, make sure you’re not paying a higher interest rate than you qualify for, most of your monthly payment is going toward paying down principal rather than interest charges, you’re prioritizing your loans with the highest interest rates, and you have a good cash balance equal to at least six months of living expenses.
Let’s look at some strategies to manage your credit card, student loan, and mortgage debt and get better prepared for the next recession. Here’s how to make a lot of money in the next economic downturn, which typically happens every 5-10 years.
Refinancing student loans is a good idea in a falling interest rate environment, or any time your creditworthiness has improved. Rates on federal student loans are fixed once you take them out, but rates for new borrowers are adjusted at the start of each academic year. Grad students and parents pay higher rates, so many borrowers are paying 6%, 7%, or 8% interest on federal student loans.
In a falling interest rate environment, many graduates who have a history of earnings and credit can qualify for better rates from private lenders. But check rates with multiple lenders, and remember you’ll lose access to federal programs like income-driven repayment if you refinance government student loans with a private lender.
When refinancing a mortgage, you’ll have to weigh the savings you can achieve if you get a lower interest rate against fees charged by the lender. You can use a "break-even" calculator to see how long it will take for your savings to cancel out any fees.
The good news about credit card debt is your interest rate typically follows the prime rate, which follows the Fed’s short-term interest rate adjustments. So when the Fed cuts rates, your credit card rates often come down too. But when the Fed was raising short-term rates from 2015 through 2018, long-term rates didn’t keep pace. For a while, we had an inverted yield curve, when long-term rates were lower than short-term rates.
An inverted yield curve can be a warning signal that a recession is looming. But low long-term rates also create an opportunity to consolidate credit card debt. At the end of the third quarter of 2020, the difference between interest rates on credit cards and personal loans hit an all-time high. People carrying a balance on a credit card were being charged 16.97% interest, on average, but the average rate on personal loans was only 10.07%.
This huge difference has borrowers rushing to refinance credit card debt by taking out personal loans at lower interest rates, potentially saving thousands of dollars. If you’re interested in this strategy, it’s important to get actual rates from multiple lenders. Competition for borrowers is fierce, so shopping for the best rate can pay off.
By taking advantage of lower rates and wisely paying down debt, you’ll be in a much better position if the economy goes into a recession. Surviving a recession is all about having enough cash flow to make it until the inevitable recovery.
If the economy continues to soar, you’ll feel great knowing that you’ve optimized your debt while also making greater returns and optimizing your earning power. You always want to create a win-win scenario, no matter the economic environment.
Update Dec 1, 2020: The economy tanked hard, harder than anyone could have imagined due to the coronavirus pandemic. But here we are with stocks and real estate prices higher than ever before. As the economy tanked, we took advantage of lower interest rates and refinanced our debt. We also ended up buying a lot more assets with cheap money.
Update 2023: We went through a bear market in 2022, but now there are buying opportunities. I’m personally going shopping for more private real estate in 2023 and beyond.
Real estate is my favorite way to achieve financial freedom because it’s a tangible asset that’s less volatile, provides utility, and generates income. Stocks are fine, but stock yields are low and stocks are much more volatile.
The combination of rising rents and rising real estate prices builds tremendous wealth over the long term. Meanwhile, there are more ways to invest in areas of the country where valuations are lower and net rental yields are higher thanks to crowdfunding.
Even if the economy tanks, real estate will continue to pay steadily as it’s a sticky and defensive asset. The key is building more cash flow.
