What is the Impact of the Recession On a Personal Loan?

Nov 9, 2022

5

min read

T

he looming storm of the recession is raising widespread concerns about its potential damage to the U.S economy. Thus, financial experts strongly advise the public to save and prepare for the dreadful storm ahead. The most common suggestion you hear from most experts is to pay down your debts!

But we wish it was easy to do so. Debts are pitfalls that are easy to get into but hard to get out of. On top of that, personal loans are the easiest pitfalls since they do not require collaterals and are easier to get. The statistics show that personal loans are growing like weeds in the U.S. economy, with more than 20 million Americans borrowing these loans and the average loan balance being over $16,000.

Recession Chart — Source: uplyak (Freepik)

So, suppose you are one of the estimated 20 million Americans who have taken out a personal loan. In that case, you may wonder how the current economic downturn will affect your finances and how you can weather the storm. Also, if you are considering getting a personal loan, you might wonder if it is the right time to do so. Don't worry; we have everything covered in this article. So, let's dive in.

Is the USA in a Recession?

There are differing opinions on if the USA is in a recession right now. While most economists believe that the USA is already in a recession, some believe the U.S. is entering a recession very soon. A recession is defined as an economic downturn marked by two consecutive quarters of GDP decline, an increase in the unemployment rate, a fall in income, and a reduction in consumer expenditure.

Since the GDP fell by 1.6% in the first quarter and 0.9% in the second quarter, the United States is technically already in recession. However, the record-low unemployment rate was the main factor that kept the economy from entering a recession. It's below 4%, and the market is experiencing a severe scarcity of available workers—the opposite of what would happen in a recession. However, experts predict that the United States will formally enter a recession once the strong labor market begins to crumble.

How does a Recession Impact a Personal Loan?

Recessions are often accompanied by a decrease in interest rates and lending activity. There are several reasons behind this, including the supply and demand equation for the loan. Since people's jobs and incomes are uncertain during a recession, they tend to start saving instead of trying to borrow money. As a result, there is less demand for new loans, and interest rates drop.

One side sees falling demand for loans. At the same time, the other side sees falling availability. That's because banks and other lending institutions are very risk-averse during a recession. Due to the unstable economy, the risk of loan default is significant, making lenders more selective with whom they lend. Loans are made only for customers with excellent credit ratings and repayment records.

Out of Money — Source: Pikisuperstar (Freepik).

On top of that, personal loans are riskier for the lender since they are unsecured loans. Since there are no collaterals for unsecured loans, the lender has no legal right to seize the borrower's property in case of a loan default. Since there is a high chance of defaults during the economic downturn, lenders are reluctant to lend unsecured loans. Thus, approval for personal loans during the recession is very low.

Also, read Recession And Its Impact On The Housing Market

COVID Recession and Its Impact on a Personal Loan

The USA witnessed its shortest recession during the pandemic lasting only two months. Since most businesses were closed because of the lockdown and covid restrictions, the pandemic significantly affected people's income. In light of the pandemic's potential economic impact, the Federal Reserve lowered interest rates to near zero to keep the credit flowing. The banking institutions also offered Covid 19 personal loans and other forms of support to help people make ends meet until they recover financially. Loan rates were low, with some options providing zero percent interest rates.

How do Interest Rates Impact the Personal Loan?

The Fed is hiking the interest rates to combat the decade-high inflation. Consequently, interest rates have risen dramatically. High-interest rates significantly impact the loan and the borrower, but personal loans are slightly different. The impact of the market interest rates on borrowing depends on whether it is a fixed or variable-rate loan. Fixed-rate loans are pegged to a certain interest rate that does not change during the borrowing term, while variable interest rates fluctuate based on market circumstances.

Interest Rates Declining — Source: Pch.vector (Freepik)

Personal loans are typically fixed-rate loans, meaning the interest and monthly payments will remain constant over the life of the loan. Thus, you lock the loan and interest rate at the current market rate, protecting them from future interest rate increases. If you have already gotten a personal loan before the interest hike, you don't have to worry about the increased interest rate since you will pay the rate when you take out the loan.

However, the interest rate will impact the people thinking about getting a new personal loan. If the interest rate is high, you will lock the high-interest rate for the entire borrowing term. It may be worth it if the interest rate increases in the future. But here's where things get a little tricky: a fixed interest rate can protect your loan payments from interest rate spikes, but it will also cost you more than the going rate of interest if the interest rate drops. You may refinance your loan or take out a new one at more favorable terms.

Also read: Interest Rates Are Rising, But Are Still Historically Low

Should You Take Out Personal Loans During the Recession?

The standard advice during the recession is to pay off debt as much as possible and avoid taking new loans. Understandably, if there is economic uncertainty, you never know what could happen, and taking a new loan would make it even worse. But, there is no golden rule that you should not borrow during the recession, which all boils down to your circumstances and needs. The most important things to consider are whether or not you really need it and whether or not you can afford to repay the loan.

Here are some circumstances when you should take out a personal loan during the recession:

Debt Consolidation

One way of paying off debt is consolidating high-interest-rate debt to one lower-interest-rate loan. Personal loans are popular debt consolidation options to pay off the high rate credit card debt. Credit card interest rates are variable and subject to market conditions. On top of that, interest rates on personal loans are comparatively lower than your two digits credit card interest rates.

Credit Card Debt — Source: Tanuskabu (Freepik)

Emergency Expenses

Emergencies do not come knocking on your door. It can happen anytime, and it does not matter if it's a recession or not. Financial or medical emergencies require much money, and personal loans can be the best way to manage the fund.

Wedding Expenses

Okay, because it's the recession, you won't postpone the long-awaited wedding, right? While it is true that you should try to minimize extravagant expenses during the recession. A wedding is the biggest day of your life. So, a personal loan can be the best option to fund the costs for your big day. Just make sure you are spending money that you can afford.

Is It the Right Time to Borrow Personal Loans?

If you need a personal loan, then this is the right time. With inflation rising, the Federal Reserve has been and will continue to increase interest rates to combat inflation. The average personal loan rate has risen from 10.41% to 11.27% (November 2022). Rates are expected to grow much more. Thus, it would be wise to borrow the loan and lock the rates now. Also, since the market interest rate has risen dramatically, it is a good idea to consolidate your high-interest credit card debt with lower-rate personal loan debt.

Also read: How To Financially Prepare For An Economic Slowdown

Top Lenders Offering Personal Loans

Lender	Estimated APR	Loan Amount	Loan Term	Min. Credit score	Best For
SoFi	7.99% to 23.43%	$5,000 to $100,000	2 to 7 years	650	Low-interest rates and no fees
Discover	6.99% to 24.99%	$2,500 to $35,000	3 to 7 years	660	Low-interest rates and no fees
Happy Money	8.99% to 29.99%	$5,000 to $40,000	2 to 5 years	640	Credit card debt consolidation
Avant	9.95% to 35.95%	$2,000 to $35,000	1 to 5 years	580	People with low credit scores
Best egg	7.99% to 35.99%	$2,000 to $50,000	3 to 4 years	600	Low-interest rates and flexible loan amounts
Lending point	7.99% to 35.99%	$2,000 to $36,500	2 to 5 years	590	People with low credit scores and quick funding

BHG money	10.49% to 29.99%	$20,000 to $200,000	3 to 6 years	660	Large loan amounts and flexible loan terms
Marcus by Goldman Sachs	6.99% to 24.99%	$3,500 to $40,000	3 to 6 years	660	Flexible loan terms and no fees
Prosper	6.99% to 35.99%	$2,000 to $50,000	2 to 5 years	560	Joint loan option and fast funding
#Upstart	5.60% to 35.99%	$1,000 to $50,000	3 or 5 years	600	People with low credit scores and fast funding
Reach Financial	5.99% to 35.99%	$3,500 to $40,000	2 to 5 years	600	Customizable monthly payments and fast funding

Conclusion

With the recession around the corner, it creates economic and job uncertainty. There is a high chance that your revenue sources may be disrupted, and if you are in debt, staying afloat throughout the recession will be difficult. This is why most experts suggest paying off debt as soon as possible. Recession lowers the interest rate, which might seem favorable for the borrower, but the strict lending criteria make it difficult to get the loan at this time. While most experts suggest not taking a new loan during the recession, if you need the fund urgently and can repay the debt, then personal loans are the best way to fund them since they have lower fixed interest rates and flexible repayment terms.