Monday, October 15, 2007

Personal Finance in a Recession

Will there be a recession? That’s the TV interview question for numerous economists, and their answers range from yes to no. If the question is changed to whether the economy will slow down, the answers range from yes to yes. Whatever your personal prediction, it seems that rougher waters are likely in the next year or two. How can you prepare?

I. While You Have a Job

First, let's look at what you do now, while you've still got a job.

Cash. Build up an emergency cash reserve of three to six months' living expenses. This means all your expenses, including the mortgage, car payment, student loan payments, credit card payments, gas, groceries, utilities, clothing, entertainment, and whatever else. Now more than ever, cash is important. Cash puts you in the driver’s seat during a recession.

Reduce credit card debt. Credit card debt is very expensive—some cards have interest rates as high as 30%. Interest expenses are an extravagance if money is tight. Also, paying your balance down gives you some unused credit to fall back on in case you need it.

Avoid payday lenders. This means starting now. Their goal is to rope you into a continuing series of loans (with a continuing series of expensive fees). If you get hooked on their product now and then are laid off, you could get clobbered.

Switch to a fixed rate mortgage. If you face the possibility of an increase in monthly payments in the next couple of years, think about refinancing now, while you still have a good job. If you lose your job and your payment rises, you could be caught between a rock and a hard place and end up in bankruptcy. Even if a fixed rate mortgage increases your current payment, you’ll have your interest rate risks under control. A fixed rate mortgage is preferable anyway (see Its payments don't increase with inflation. Most salaries do increase with inflation, which means that, over time, your mortgage gets a lot cheaper. Baby Boomers may remember that their parents had monthly mortgage payments of $125 to $200. Those payments were pretty big at first, when the parents made $6,000 a year (or $500 a month before taxes). But, by the 1970s and 80s, when the parents made $20,000 or more a year, those payments were lower than car payments.

Take care of important medical care. If you need significant medical care, do it now, while you’re still employed and insured. Do you need a knee or hip replacement? Have you been putting off that colonoscopy? Does the fibroid keep getting bigger? While many medical procedures can’t be timed, don’t put off to tomorrow what you should do anyway today, while you still have a job.

Think about any valid disability claim you have. If you would be entitled to disability, think carefully about delaying it. If you’re laid off, you may lose the disability coverage. Collecting disability is a major step away from future employment, and it could mean that you’d be unable to get your career back on track if you later recover from your disability. But it also means a steady flow of income (albeit lower than your salary).

II. If You Lose Your Job

If the worst happens, and you lose your job, keep your head up and eyes open. Job loss can be emotionally devastating, but a lot remains at stake, so focus on the future.

Check out your benefits. Look into severance benefits, health insurance coverage, payment of accrued vacation and sick days, payment of bonuses and commissions you’ve earned, retention of stock options and restricted stock (or your ESOP account, if you have one), and any other elements of your compensation or benefits. Get a statement of the balance of your 401(k) account (it should not be affected by your layoff, except that neither you nor the employer will make more contributions). Consult with your union, if you belong to one.

Continue health insurance coverage. If you can exercise COBRA rights to retain your current employer’s health insurance policy, do so. Even if you think you might be able to buy coverage at lower expense under an individual policy (that’s not a high probability unless you reduce coverage), protect yourself through COBRA. Then, take your time to do a price and benefits comparison. If you lose your COBRA rights up front, you could end up in a tight spot.

What if Your Employer Shuts Down? In extreme cases, your employer may go out of business. If so, it’s likely to go into bankruptcy, and you may get little or nothing in the way of severance benefits. However, there are some things to keep in mind.

First, your pension may be protected by the Pension Benefits Guaranty Corp., a federal agency that guarantees pension benefits up to certain limits. Check with your pension administrator.

Second, your 401(k) account should be intact, although any employer stock in it will probably be worthless. If you have an ESOP account, that will probably be worthless, unless you've diversified its investments away from just holding your employer's stock. Diversification is something only employees who are 55 or older and have been with the company for at least 10 years can do--and they should, for safety's sake.

Third, your health insurance plan may have been terminated just before the employer shut down. This is a nasty tactic that some companies use at the last minute. If it happens to you, you won’t have any COBRA rights because there won’t be any health insurance plan to provide you with continuing coverage. However, a federal law called HIPAA gives you guaranteed access to an individual policy for 63 days after the employer’s health insurance plan terminates. Buy an individual policy before the 63 days runs.

Apply for Unemployment Compensation. If you’re eligible, apply for unemployment compensation. It’s there for people in your situation. You’ll have to demonstrate that you’re making efforts to find a job. But you should look for another job, anyway. Staying employed is one of the best ways to maintain your financial well-being, health and self-esteem.

Sell unneeded stuff before borrowing. If you’re running short of cash and still have no immediate prospects for new employment, sell off stuff you don’t use or need any more. If you haven’t used the trailer with the popup tent in five years, you probably won’t use it in the next ten. If the golf clubs have decorated your basement for the better part of a decade, they’d probably be happier in the hands of someone who might actually take them onto the links. What about all that stuff in large plastic boxes in the crawl space just below the roof? Why will it benefit you if it stays there another five years? It’s best to avoid borrowing while unemployed, because you have no obvious way to repay the debts. While jobs may be impermanent, debts are a certainty. Avoid them.

Reduce spending for services. Now that you have a lot of free time, mow the lawn yourself. You did it when you were 14. You can do it now. And think about cutting back or terminating the housecleaning service. Pushing a vacuum cleaner or cleaning a bathroom isn’t the worst thing in the world, not when you compare it to going into bankruptcy and losing your home. Cut back to basic cable. Yes, you have more free time, but will it be fruitfully used by vegging out in front of the tube? If you’re not working, do you need an expensive cell phone plan? Who will you be talking to all the time, now that no one needs your signoff on the latest proposal? Unnecessary consumption isn’t the way to survive a layoff.

Avoid get rich quick schemes. Particularly nasty vultures posing as people hover around during bad times, looking for the weak and vulnerable. If you’re unemployed and desperate, count yourself among their potential prey. When you’re in dire need of money, it’s easy to believe what you want to hear. And lots of con artists will be there to say it in the hope that you will give them some of your now scarce cash. Get rich quick schemes are usually a surefire way to lose money. For more on fraudsters and crooks, go to

Fashion Update: handcuffs.

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