How do I prepare for a recession if I have debt?

What is a recession?

The answer to this question can be confusing, so we’ll make it as simple as possible here. 

Economists define a recession as two consecutive quarters of negative economic growth.

In simple terms: a recession is a period of significant decline in economic activity that lasts for several months or more.

During a recession, businesses produce less, people lose jobs, and consumers spend less money. Some recessions last less than a year, while others stretch on for several years. 

Regardless of how long it lasts, a recession typically leads to lower employment, reduced consumer spending, and slower economic output.

What causes a recession?

There are various things that can cause a recession, these include: 

• Tariffs: Tariffs is word we’ve all heard a lot since the re-election of Donald Trump. Tariffs are usually imposed and collected by a country’s customs authority or agency when goods cross the border. According to the Business Development Bank of Canada, their purpose is to increase the attractiveness of domestically produced goods relative to imported goods. Buyers are usually responsible for paying tariffs. Companies could have to pay a tariff if they import goods into Canada. If companies are exporting their products, their clients abroad may have to pay tariffs on the goods you sell. For Canadian consumers, this means a concrete increase of prices at the store. 
• High inflation: Inflation makes prices go up, raising the cost of living for consumers. As prices rise and consumers reduce their spending, it slows economic growth. 
• Rising interest rates: If interest rates rise too quickly, it makes the cost of borrowing more expensive. This often makes consumers reduce spending and in turn causes the economy to slow down.
• Excessive debt: When many people are unable to meet their financial obligations, it can result in bankruptcies and trigger a chain reaction of economic instability.
• Asset bubbles: This is when asset prices rise rapidly over a short period, but these price rises do not accurately reflect the real value of the asset. Eventually, if these asset prices crash, it can be a cause of a recession.

So, when a recession happens, what does it mean for regular Canadians?

What happens during a recession?

• Consumers, businesses borrow less and spend less money
   Recessions create an environment of uncertainty, as a result, people are less willing to take on debt or spend because they are unsure if they can afford to repay the money. Businesses will also look for ways to reduce their costs as well. This may mean scaling back or delaying major projects.
• Businesses make cuts and lay off workers
   As people cut back on spending, many businesses see a drop in sales and revenue. To manage the loss, they often lay off workers or reduce staff hours to lower operating costs. Some businesses may put in place a hiring freeze, meaning they stop hiring new employees for a certain period.
• Unemployment goes up
   With more people being laid off, the percentage of the population who is unemployed rises and so do insolvencies. This means an increase in the number of people having to file a consumer proposal to reduce their debt load or declare bankruptcy to remove large portions of their debt. 

On the ground, a recession means all sorts of challenges.              

For many people, a recession may mean losing your job, and it can be even harder to find a full-time job during a recession. Even those who keep their jobs may face wage freezes or increased costs, putting more pressure on household budgets.

Focus on your own situation

Focus on what you can control: your budget, your income, and your debt. 

In many ways, recessions are brought on by a collective shift in spending habits: consumers spend less and borrow less, which has a ripple effect throughout the whole economy causing businesses to look for ways to cut costs. 

While less spending and borrowing less can lead to a recession, it’s the right thing to do during a recession. 

During any period of economic uncertainty, you should be looking to cut costs and tighten your budget. Reducing nonessential spending and avoiding taking on new debt can help you control your finances. You should do this both leading up to and during a recession.

If you’re able to save any money during a recession, then that’s a real bonus. If you put that money aside in an emergency fund, you will have a safety net in case of unexpected expenses, like a job loss or emergency repair. When you set money aside, even in small amounts, you’ll also reduce how much you need to rely on credit. 

Cut costs

This is the best thing you can do that will have a noticeable impact on your day-to-day financial situation. You’ll need a budget, there’s lots of strategies to choose from, so you can start unlocking savings.  

You can use BDO’s budget planner tool to help get you started.

If you’re looking for easy ways to eliminate spending here’s a few ideas: 

• Cut a subscription you don’t need 
• Price match at the grocery store 
• Cook at home and limit going out for food 
• Be mindful of energy and expenses at home: turn the heat down when no one is home, turn off lights, reduce water consumption, etc.  
• Carpool or take public transit when possible
• Change your phone or internet provider for a cheaper rate
• Postpone any big ticket non-essential spending, such as a trip, have a staycation instead

No matter what the budget, everyone has ways they can save. One great strategy for saving money is to start being a disloyal customer. 

Spend and borrow less

One of the first things to do is to limit credit card usage and to try to pay off any monthly balances in full. 

This also means reevaluating major purchases you have planned. If you were planning on taking a trip in the near future, you may wish to rethink where you go. Scaling back your plans and doing something less expensive is a great way to save money and borrow less.

The same thing goes for any major projects or home renovations done this year. If your countertop will survive until next year, it might be better to wait until then to spend the money on that renovation.

Right now, should I save or make debt payments?

The answer to this will vary from person to person, but here are some important points to consider. 

It’s best to do both

The reality is that if you’re able to save and pay down debt at the same time you should.

The biggest financial threat during a recession losing your job. You therefore need to ensure you have savings AND room to spare on credit products in case EI doesn’t cover any shortfalls.  

If you have credit card debt, that means reducing your balance to a manageable amount where your monthly payments are affordable.  

It also means reducing the balances on more low-interest forms of credit, such as a home equity line of credit (HELOC). This will free up more space for you to borrow in the future if you have to. 

You also want to put whatever money you can into an emergency fund, so you don’t have to rely on credit straight away if you do lose your job.

Of course, not everyone can afford to do both. Our blog on whether to save or pay off debt can help you see which one makes more sense for you.

Seek new forms of income

If you have some time on your hands to take on another job it might be worth exploring the idea of gig work or freelance. 

Not all freelance and gig work has to be for a company. You can work for yourself. From tutoring to dog walking, the ideas for an extra stream of revenue are almost endless. 

You can take freelancing to the next level and create a side hustle. Side hustles can include driving an uber, or delivering food for a delivery app. 

It may also mean starting to work on something you’re passionate about with the hope it will eventually become your full-time job.

The easiest way to earn extra money, of course, is to sell your own stuff. If your house is full of things you no longer need you can put them up for sale online, or even have an old-fashioned yard sale to earn some extra money..

You can use any extra money you make to pay down or keep up with your debt.  

What if a recession pushes your debt too far?

For some people a recession will be the thing that pushes them and their finances over the edge, often because they lose a job through no fault of their own.

If you feel you’ve run out of ways to handle your debt on your own, there are solutions available. Book a free consultation with one of BDO’s Licensed Insolvency Trustee’s and we can assess your situation and show you a personalized program to get you out of debt. 

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