Consumer debt in the current economy
Recession, pandemic create unusual environment
In normal times, the advice people hear about their consumer debt usually follows a familiar pattern. Focus on your highest-interest debt first, or pay off your smallest balance first.
But we’re in an economic recession in the middle of a pandemic. And in the current environment, different approaches to consumer debt may be appropriate.
Here are some issues to think about:
- Setting low interest rates has been a key component of the Federal Reserve’s response to the coronavirus crisis. Reviewing rates on outstanding debt and refinancing / consolidating household debt to take advantage of these rates may be sensible in order to lower total interest expense.
- In considering a refinance, be sure to understand all costs involved. If transaction costs – such as closing costs on a real estate loan – will offset the savings from a lower interest rate, it may be better to maintain the original loan.
- Carefully consider any changes to the term of a loan. A lower interest rate over a longer term may not save you money in total interest expense.
- Millions of jobs have disappeared this year, and many of them won’t come back. If a household’s emergency fund won’t provide for 6-9 months of living expenses in the event of job loss, it may be better to reduce excess debt repayments to build an emergency fund more quickly.
- Paying down debt as quickly as possible usually is a good approach. But debt management should not be viewed in a vacuum during a time when the likelihood of income declines or job loss has increased significantly for much of the population.