Should You Save or Pay Off Debt During a Recession?
As the UK prepares for the coming recession, Brits will have hundreds of questions about what the recession will mean for them. While there’s a lot of uncertainty going around, there are many ways to get your finances into the best shape possible.
One of the first things to do when a recession is on the horizon is to assess the debts you’re currently carrying. During a recession, you’ll want to ensure you’re taking the right actions on every type of credit you use. In this post, we’ll cover the best practices for managing credit card debt, mortgages, personal loans, and other debts during a recession, and when you’re better off saving.
Eliminate Your Credit Card Debt
Reducing debt on high-interest credit cards is one of the best things you can do for yourself in the face of a recession. Credit cards almost always have higher interest rates than most other forms of credit, aside from risky types of credit like payday loans, and will accrue debt more quickly.
Additionally, many credit cards have a variable interest rate, which means your interest rate will go up as the Bank of England base rate goes up. The BOE base rate has risen from 0.1% in March of 2020 to 1.75% as of 4 August, 2022.
With inflation in the UK on the rise and a recession looming on the horizon, you need your money to go further wherever it can. Eliminating credit card debt that needlessly eats away at your funds is one of the best ways to do that. Plus, it will lower your credit-utilisation ratio, which can help make you eligible for better interest rates, which are a huge benefit during a recession.
Related Read: What is a Good APR for a Credit Card in the UK?
Don’t Fall Behind on Mortgage Payments
With the Bank of England raising interest rates, your monthly mortgage payments could significantly increase. Tracker mortgages and variable rate mortgages are almost sure to see increases to their monthly payments, as they’re tied directly to the BOE’s base rate. It’s crucial to be aware of how this can affect you, as an increasing interest rate could cost you as much as £1,000 over the course of a year.
It’s essential to be prepared for these potential increases. As the recession is expected to worsen, and energy prices are on the rise, there are several factors at play that will have significant impacts on your budget. Considering how your mortgage could change will allow you to start making the necessary adjustments in your budget so that you don’t fall behind on payments. Late mortgage payments can remain on your credit report for a long time—as long as seven years—and can do serious damage to your credit score. Granted, it’s not impossible to recover from damage to your credit score, but doing so during a recession is less than ideal.
Households with fixed-rate mortgages will fare better, at least for the remainder of their mortgage terms, which are typically between 2-10 years. However, if your mortgage terms are coming to an end, you’ll want to be sure that you can lock in a favourable new interest rate.
Need more information about the BOE base rate? Check out our blog on the subject: What is the Bank of England’s Base Rate and How Does It Affect Me?
Should You Pay Down Other Debts During a Recession?
Because interest rates have risen and paying off your credit card debts is so vital during a recession, you might think that you should also try to get out of all your debts as well. However, keep in mind that if those debts have lower interest rates locked in, it might be less prudent to focus on them.
That’s not to say you shouldn’t determine the best move to make for each line of credit. However, during a recession, having immediate access to savings matters.
Why Are Savings Important During a Recession?
Consider the following situation: you start paying off a loan at an accelerated rate, and dip into your savings to do so. It goes smoothly for a while, and you’re seeing the remaining portion of your loan shrink, but then disaster strikes: you lose your job, are involved in a car crash, or fall ill. Suddenly, you’re unable to maintain your payments, and because you’ve been paying them off aggressively, you also don’t have a safety net of savings to rely on now that you need it.
Ultimately, if paying off debts like a loan at an accelerated pace will put you in an unstable financial position, it’s probably better to maintain a normal payment schedule. It’s unlikely that maintaining your regular payments will damage your credit, and it allows you to keep cash on hand in case you need it.
However, if you’re simply determined to get out of debt, make sure you have a plan. To learn more about getting out of debt, read our guide: How to Get Out of Debt in the UK.
Protect Your Finances and Your Credit With Pave
A recession can flip the script of traditional financial best practices. Eliminating debts can be helpful, but it depends on the type of debt. For example, cutting down your credit card debt will be a huge help, while aggressively paying off personal loans could put you in a delicate financial position. Ultimately, you’ll want to be prepared for how your debts will be impacted by changing interest rates and focus on your debts accordingly.
Eliminating credit card debt during a recession is a great way to boost your credit score, but it’s not always easy. Fortunately, the Pave app can help. Our bills monitoring, active credit building, and personalised credit fixes can help you find ways to give your credit a boost as you continue your credit-building and debt-eliminating journey throughout the recession.
A recession can be scary, but you don’t have to go through it alone. Download the app from the App Store or Google Play today to see for yourself why hundreds of thousands of Brits have turned to Pave for help building their credit.