It seems like personal finances can take a hit at any time these days, but this is particularly true during a recession. While practices and institutions in place, such as the Federal Reserve, act to help combat recessions, they are still unavoidable at times. These times may leave you thinking, “is it good to take a loan during a recession?”
What Is a Recession?
A recession is a period of time during which there is a decline in economic growth and activity.
The time from which a recession starts to when it ends may last a few months or a few years, depending on the overall financial situation. During a recession, you may see an increase in auto and home prices. This price increase is because automobiles and homes are big-ticket items that people may need to purchase anytime, even during an economic downturn. Other prices that often increase during recessions are the price of food, water, and other daily necessities that every person needs. Unfortunately, recessions can make it easy for people to fall into a financial crisis just trying to pay for everyday living expenses.
Some circumstances that can cause a decline in economic activity and lead to a recession are:
- When the economy experiences a negative gross domestic product (also known as the GDP).
- When there is an increase in unemployment and the number of people without jobs.
- When there is a significant decline in retail sales.
- When there is a major difference between income and manufacturing efforts for an extended period of time.
- Where there is excessive inflation or deflation.
- When the country experiences an economic shock, such as the Covid-19 lockdowns and economic shutdowns.
How Does an Economic Downturn Affect the Lending Industry?
The price increases resulting from a recession can leave consumers looking for ways to get a bit more income. Since it is common for more people to be looking into loans during a recession, lenders must be particular about what applications they accept and to whom they lend money. Unfortunately, this trend can encourage lenders to reject applications for borrowers with a less than perfect credit score.
Your credit score is based on information collected by the major credit bureaus. The major three credit bureaus are TransUnion, Experian, and Equifax. Your credit score, as well as a few other factors, are included in your credit report. Someone’s credit score often plays a big role in what types of loans and financial products they are eligible for. While some lenders may be relaxed on their credit score requirements during an economic upturn, they usually buckle down, and may even increase their eligibility requirements regarding loan approval during a recession.
How Do Recessions Affect Interest Rates?
Lending money is more of a financial risk during a recession, often leading to lenders boosting interest rates for loans and other financial products. For example, recessions may cause a drastic increase in mortgage rates, making buying homes and affording mortgages much more difficult for the average person.
Where Can You Borrow Money During a Recession?
Instead of asking a close friend or family member for money, you may want to look for extra funding elsewhere. Below are a few places where you may be able to find a loan during a recession:
Banks are a type of traditional financial institution that offers loans as well as other financial products. While most people go to a bank for checking and savings accounts, people can also utilize banks for personal loans, mortgages, auto loans, and more. However, keep in mind that having a bank account does not guarantee approval on loans or other financial services with that particular bank.
When banks set interest rates on loans, they will rely heavily on the borrower’s credit score.
Unless your credit report is ideal, you may not be able to get the best interest rates on a bank loan during a recession.
Those without good credit may be able to find a lower interest rate with a loan from a credit union. Retail banks differ from credit unions in that banks are ultimately looking to gain a profit while credit unions are ultimately non-profit. Since borrowers are the people who own credit unions, they are typically more interested in providing special borrower perks and rewards, like optimal interest rates, instead of making money.
While credit unions may offer great deals on loans, they may also come with strict eligibility requirements. For example, credit unions may only provide services to consumers who live within a certain area or earn an income within a particular range.
One of the most versatile places you may be able to find a loan during an economic downturn is through a private direct lender. Direct lenders can offer a variety of different loan products, such as:
Since there are so many financial products available, you may be able to qualify for funding with several different direct lenders. To make sure you get the best deal, research a few lenders before committing to one particular loan. See who can offer you the most convenient monthly payments and repayment terms, and go with the lender who will be able to help you out the most.
What Kinds of Loans Could You Get During an Economic Recession?
Banks, credit unions, and direct lenders may offer any of the following types of loan products at any time, including during a recession:
Secured vs. Unsecured Loans
Consumer debt is typically broken up into two categories, secured and unsecured debt. Secured debt, also known as secured loans, requires collateral. Collateral is a piece of property containing equity that borrowers can use to secure loan funding. Mortgages and car title loans are two examples of secured debt. With mortgages, the borrower’s home is used as collateral, while the borrower’s vehicle title is used as collateral during a car title loan.
Unsecured debt, also known as unsecured loans, does not require collateral. Depending on the lender and the loan product, borrowers may use other factors to qualify for an unsecured loan. For example, credit scores or proof of income are two factors lenders may consider when determining loan approval.
Long-term vs. Short-term Loans
Depending on the amount of money you need to borrow, you may find that a long or short loan term will work best for you. A short-term loan plan may be an excellent fit for you if you only need to borrow a few hundred dollars to take care of some unexpected bills. However, if you are trying to take care of larger expenses, you may want to give yourself a bit of breathing room with a long-term loan.
Tips for Paying off Loans During Recessions
No matter when you get a loan, it should always be a priority to stick to your agreed-upon payback terms. When you stay consistent with your payment history, you may find it easier to get approved for better loans in the future. You could even see an increase in your credit score! Here are some tips you can use to pay off your loans during a recession.
Make More Than the Minimum Monthly Payments
To save money on interest rates over time, make more than the minimum monthly payment on your loans. Paying more than required each month will put you ahead of your original payback schedule. Depending on how much extra you pay each month, you could save hundreds or even thousands of dollars on your loan overall!
Avoid Applying for New Credit if You Can
During a recession, high-interest debt is more common. To avoid getting sucked into debt and sacrificing more of your income, try not to apply for a new loan or credit card if you don’t absolutely have to.
Sign Up for Automatic Payments
If you find it difficult to remember to make your monthly payments on time, consider signing up for automatic payments. Also referred to as autopay, automatic payments allow lenders to take money directly from your bank account on your loan payment’s due date. You can even set your automatic payment date to be on days you receive a paycheck to ensure you always have enough money in your account.
Refinance and Consolidate Debt if You Need To
If you currently have a loan with interest rates you can afford or a repayment plan you have difficulty sticking to, it may be in your best interest to refinance. By refinancing, you may be able to take advantage of perks like:
- Low-interest rates.
- New payback schedule.
- Higher loan amount.
- Decrease monthly payment.
Bottom Line: Loans During a Recession
While getting a loan during a recession may be a bit more difficult, sometimes it is the only option. To keep your credit score intact and ensure you get the best loan deal, do some research before committing to any loan product.