With the recession well underway, I think it is worth discussing how to manage debt in it. When I got notice that I was going to be laid off, Linda and I immediately began strategically planning for worst-case scenarios. After looking at our financial situation, we realized that by eliminating the few remaining debts we had, we would be able to cut our monthly expenses by $500 or so.
My thinking was, if I am without income for a few months, I want our monthly expenses to be as low as possible in order that we can survive on a lower income for a longer amount of time. My student loan was sitting at about a $15,000 balance and only required a $100/month payment. So, it seemed that after paying off the other debts and reducing our monthly bills by $500, the next best thing was to fill our emergency fund up with cash – rather than trying to knock out a $15,000 debt that would only cut our monthly expenses by $100.
So as we continued to prepare for my layoff, we filled our emergency fund and when the severance check came, it went right to the emergency fund as well. So as I began my career as a blogger, we had greatly reduced our monthly expenses, while filled up a savings account with cash to hold us over for a while.
This all seems perfectly logical to me. But I am probably a little biased. 
Should you pay your debts down during a recession?
The reason I mention how we handled things, is because I just read an ebook that suggested somethings that seem a bit off to me. The author suggests quite a few things I am in agreement with (for people preparing for a layoff)…
- Negotiate credit card debt
- Don’t save for college
- Don’t contribute to your 401k
- Become a star at work
But the book goes on to recommend only paying minimums on all debts and actually taking out a home equity loan to fill up a savings account with cash! What makes it worse is that the book isn’t necessarily written to those getting laid off, just to people trying to survive the financial crisis. I feel like taking out a loan to stockpile cash just because the economy is struggling, seems a little far-fetched. Am I crazy?
So, it could be confusion between the author’s intentions and how the book is titled, but taking out a loan to hoard cash seems like an extreme measure that should be reserved for the absolute worst case. Maybe he is thinking that it would be better to get a home equity loan than to borrow on a credit card? Not sure.
How are you managing your debt?
Have you made any changes to your debt management? Are you preparing for the worst case scenario?
Related posts:
- 10 ways to survive in a recession
- How to manage your bills
- How to manage financial risk
- Is Debt Consolidation a good idea?
- How to get a great return in your 401k during a recession
- Recession cycles
- Debt reduction strategy
- Encouraging story of getting out of debt: Patrick Gessleman
{ 7 comments… read them below or add one }
Borrowing against your house if you’re facing a layoff sounds like a crappy idea to me
Pessimism is rarely an admirable characteristic. But, the when it comes to our finances knowing and preparing for the worst case scenario is essential. Often our financial plans are build on best case scenarios – when I get my raise, when I sell my product, when my kids finish school … I would save the same amount of cash if the economy was good or bad (unless I knew I was definitely going to be impacted) and I would make sure it was my money I was saving (not money I borrowed).
What this economic condition has taught me is to always have a what-if-I’m-wrong plan. My financial plan remains the same: live on less than I earn, make giving a priority, save for the future. In 2009 I have added one element to my financial plan – ignore the markets.
@Kacie Why does that sound like a “crappy” idea to you? It actually makes perfect sense if you don’t have an emergency fund. Think of it like this . . . would you rather have no job and cash to pay the bills but with home equity loan or no job, no cash, and no loan?
@Craig The “what if I’m wrong plan” is exactly what the Plan Z book is all about. If you don’t have at least 12 months of living expenses in cash, you need to do everything you can to hoard cash in case you do get laid off.
I agree that non-essential bills should be put on hold and all saving should be for the immediate need of an emergency fund and not further out goals like retirement or college. It’s a great idea to quickly build up and have an emergency fund. Having one will greatly reduce, or even eliminate, a lot of stress when something unexpected comes up, like losing a job.
However, I think there’s a trade off when borrowing against the house (or taking on debt) to build up an emergency fund.
In a scenario where I lose my job with little to no cash, I would be compelled to immediately find part time work, even if it’s near minimum wage. A $1,000 or more a month might very well cover my essentials (food, gas, basic utilities) and part of my mortgage and/or rent. I wouldn’t lose my house by being late or behind a few months. If renting, it would probably take at least two months to be evicted, even then partial payments on a plan could be made. This would all be downright nasty. But you bet I would bust my tail to get into a decent job soon.
If I have an emergency fund (based on borrowed funds), I might take a more relaxed approach to finding a job. That might be beneficial, especially during interviews, but it might also lead to decreased effort. I would be a lot less inclined to take on a part time job. Ultimately, what if the borrowed emergency funds are depleted and there’s still no job? I’m definitely in debt, might have to short sell or even face foreclosure if a HELOC put me upside down in my home.
Something to consider.
Preferably, the emergency fund is built up before the worst happens (by living on less income than I’m generating and via other suggestions). Taking on debt to build it up, for me at least, is a step too far. It’s a step that I think everyone should think twice about.
I would also like to share my personal situation in response to the Bob’s question.
My future at my current job is extremely questionable (it is coincidental, but not really related to the current economic troubles). Thanks to my friends, and even ChristianPF, my wife and I have become more conscious and intentional with our money over the last many months. We have intentionally made minimum payments on our outstanding loans and are stockpiling the extra we would normally apply to the debt. We have been able to build up a respectable amount to hold us over for many months if necessary. I would of course, love to secure a new job and knock out a significant portion of our debt. We also continue to give to our local church and other needs around us.
It’s easy to be fearful, but in general we remain positive despite the sobering stories in the news.
I happen to agree with your approach but it really becomes something of a sliding scale based on someone’s entry point – or the amount of cash/emergency fund they have at the beginning.
For example, I’d never be a fan of taking out a home equity loan in this situation unless there is little severance and no pre-established savings. Borrowing some float does have ’some’ merit in this case… this case being on the ‘less good’ end of the spectrum.
In your situation (and my recently too) the wise idea is to evaluate the balance to payment ratio to make the payoff decision. I don’t know what ratio would drive the decision but the size of balance and payment and Emer Fund would all be heavy factors.
So I’m being squishy but here’s the point – HAVE A PLAN. Run the numbers – your numbers – and factor in your job search plan and timeline and alternative income approaches (working spouse, part time job, etc).
Great topic, thanks for sharing!
Dave