What to do if your income may drop or stop (or if it already has)

There’s no question.

We’re in a major financial and economic crisis, worse than any most of us have ever lived through.

In just 2 weeks, 10 million workers filed new unemployment claims. (Updating to April 16, 2020, the figure has climbed to 22 million unemployed).

The Congressional Budget Office (CBO) projects unemployment to exceed 10% during this 2nd quarter of 2020, and the economy may contract faster than a 28% annualized rate!

If you’re still working, your employer may have cut your hours, and may be considering furloughing or even letting go employees.

If you’re self-employed, clients may be staying away, cutting back, putting plans on hold, or outright canceling them as they try to stem the tide of red ink.

Scary.

But all is not lost…

What this Means for Your Finances

Your income may have dropped or even stopped altogether. Even if it hasn’t, there’s no way to know if it won’t happen tomorrow, next, week, or next month.

It’s past time to start managing your finances in crisis mode. That means you have to cut your expenses as much as possible, increase your income if and as you can, and be strategic about your debts.

Paying down most debt is normally a very good idea, but during a recession it's probably a very bad one.

Yes, debt payments are a bigger problem when your income goes down. Where you may have been able to make ends meet and still make your minimum payments on credit cards before, now that may be impossible.

Worse, if you’re used to opening new credit cards to cover ongoing shortfalls, lower income makes it harder to continue borrowing more.

You may be facing some harsh and inescapable financial realities.

5 Things You Can Do Now

Here are 5 things you need to do, or at least consider doing to minimize the impact of the current crisis on your immediate and long-term future.

1. Triage Your Spending

First, go through your spending of the past months and trim wherever possible.

Paraphrasing from the excellent business book Profit First, that means cutting anything that’s not needed for survival, and looking to replace things you do need with less-expensive alternatives.

What you’re doing here is cutting your cost of living as close as possible to (or preferably lower than) your current income.

2. Try to Bolster Your Income

Next, get creative in coming up with some extra cash. What can you do to bring in a bit of extra cash while you’re prevented from going out as much as you used to?

Perhaps there’s something your employer (or client) needs done that you’ve never had time to do, but that would position them further ahead once the pandemic is over. That’s a good direction to explore if your hours are being cut because business is slowing down.

Try writing and selling digital products such as ebooks on something you’re expert in that can help people solve a problem, preferably one that’s top of mind with everyone stuck at home. If there’s enough demand, consider creating a subscription service. If setting up a new business like that is too much to handle now, you can at least post articles on sites that pay writers.

If you have a ton of stuff you don’t need laying around, try selling it on eBay or Craigslist. It’s clearly not the best time for that, but as they say, one person’s trash is another’s treasure. Maybe your clutter is exactly what someone else is looking for in the quest to find something fun to do while shut in at home.

As an added benefit, doing all this will keep you busy, rather than moping or obsessing over things you can’t control

3. Continue Making Minimum Payments

Unless it means losing your home, your utilities, health, or food, keep making those minimum payments.

Failing to do that could drop your credit score like a rock. That would be bad news because a good credit score helps you get less expensive new credit when you need it (see below), and may mean lower insurance costs or the ability to get into a new rental home if you have to move.

Note that during the current pandemic, your landlord may not be allowed to evict you for non-payment of rent, and your mortgage issuer may forbear payments. However, just because you can do these doesn’t mean you necessarily should. In the case of your landlord, once the pandemic is over you may owe a lot of back-rent, potentially with interest. In the case of mortgage, even if the bank doesn’t foreclose on your house, interest will continue accruing, which will drop you deeper and deeper into debt.

4. Consolidate Debts

If you have multiple credit cards and other consumer debt, consider consolidating all those into a single new debt (but only after you’ve gone through step 1 above to make sure you don’t spiral deeper into debt just because you have more credit available).

There are several options to consider here.

• Open a new credit card with an 18-month 0% interest teaser rate (see e.g. CreditCards.com, or NerdWallet.com) and transfer all your balances there.
• Depending on your credit score, you could get a 5-year unsecured loan at under 8.2% through a peer-to-peer lending site such as LendingClub.com. I’ve even seen loans below 11% interest for a borrower with a sub-695 credit score. (In the spirit of full disclosure, I have a bit of money invested in loans made through LendingClub)
• If you own your home and have enough equity, contact your mortgage advisor regarding a possible cash-out refinance to consolidate your debt. If you haven’t refinanced in a while, you may find that the new loan could be at a lower interest rate than your current mortgage, possibly cutting your mortgage payment while paying off all those other debts.

Here’s how this could play out. Say you owe:

• $10,000 on a Visa card charging 23.43% interest (typical if you have “fair” credit, according to Wallethub.com)
• $5000 on a store card charging 25.44% interest
• $202,350 on your mortgage (close to the national average, according to Experian) at say 5% (plausible if you haven’t refinanced in the past few years)

Assuming your cards require a minimum payment of the higher of $25 or 2%, plus accrued interest, your minimum payments would be:

• $395.25 on your Visa card
• $206.00 on your store card
• $1207.85 mortgage payment (excluding homeowners insurance and property taxes; this assumes a 30-year fixed loan with an initial amount of $225,000, that started about 6 years ago)

Your total debt payments here would thus be $1809.10/month.

If you transfer your two credit card balances to a new 0%-interest card and pay a 2% minimum on that card’s new $15,000 balance, your card payments would drop to $300, saving you $301.25/month. However, keep in mind that in 18 months your interest would jump much higher, so while you’d save a good deal of money until then, you’ll have to solve another problem once the teaser rate ends.

If instead, you take out a 5-year $15,000 loan from LendingClub at 9% interest, that payment would be $311.38, saving you $289.87/month. This isn’t as much savings as the previous idea, but it will provide a fixed payment plan that will see the full $15,000 paid off in 5 years.

Finally, let’s look at consolidating all three of your debts into a single new mortgage, say at 4% interest. Let’s assume you’ll also roll $3000 worth of closing costs into the new loan. Your new balance would be $220,350 (neglecting the difference between your current loan balance and the payoff amount). Your new payment (principal and interest) would be $1051.98. That’s $757.12/month less than your current payments!

Note that you will have restarted the clock on your mortgage, so you’ll pay about $16,000 more in total than you would have if you made no changes. While this is not great news, you do get the following benefits:

1.       Your current cash crunch is a lot lower

2.       Considering inflation and the mortgage interest deduction that you may be able to take, your real costs will end up a lot lower than that $16,000, and possibly even less than zero! 

5. If You Can’t Consolidate but Have Extra Cash

You could choose to pay down some of your high-interest debt. You could then see the larger available credit on the card as your “emergency fund.” However, your card issuer may suddenly decide to cut your credit limit down to your current balance. Especially if this happens at the exact time you lose your income, you’ll have no liquidity and few good options.

You could instead put the extra cash into an FDIC-insured bank savings account – according to Bankrate.com, you could get up to 1.7% APY on some accounts. That combines safety, liquidity, and at least enough interest to counteract inflation.

If you have plenty of cash piled up in a safe and liquid place, consider if investing in the stock market when its more than 25% off recent highs isn’t a good long-term play. (Updated to show that after the recent partial recovery in the markets, as of April 20, 2020, the market is about 17% off its February 19, 2020 peak).

3 Things to Avoid Doing Now

First and foremost, don’t panic and make rash decisions. In terms of investing, that could mean selling all your long-term investments, locking in losses that are currently just on paper.

Second, don’t (continue) to buy things you don’t need with money you don’t have – also known as living beyond your means at the expense of your future self.

Finally, don’t pay down debt aggressively with cash that you may dearly miss later. This is especially true if you’ve been making extra payments against your mortgage principal. That’s rarely a good idea anyway, but unless your circumstances are vastly different than most of us, in a crisis it’s especially foolhardy. You may end up finding yourself owing less, but on a loan you can no longer afford anyway. While your lender may not be able to foreclose now, there’s no guarantee that will hold true until your situation turns around.

The Bottom Line

Especially in a crisis it often seems like everything is spiraling out of control, but if you stay calm, there are things you can do to manage your finances appropriate to the situation. Follow the above 5 do’s and avoid the 3 don’t’s, and your future self will have ample reason to thank you.

Financial strategy is all about setting financial goals, crafting a plan to reach them, and doing what's needed to start implementing that plan in both your business and personal life whether times are good or bad. If you'd like to learn what this can help you accomplish, email me and we'll coordinate a free, no-strings-attached phone call to explore that possibility.

Disclaimer

This article is intended for informational purposes only, and should not be considered financial advice. You should consult a financial professional before making any major financial decisions.