What happens in a recession?

Even though we might not know exactly what a recession is, we do know one thing about this much feared word – it’s bad news. Unfortunately, in June 2017, not only was our investment rating downgraded to ‘junk status’, but it was also made official that South Africa was in a recession. Still, there’s no need for panic. Here we explain exactly what ‘recession’ means and how you can navigate its uncertain waters.

Typically, a technical recession occurs when a country has had a decline in economic output for two (or more) consecutive quarters. Sometimes, after the initial downward turn, there is some positive growth, but it doesn’t last. Unfortunately, as outlined by the figures in The Conversation, South Africa’s ‘gross domestic product (GDP) declined 0.7% during the first quarter of 2017 after contracting by 0.3% in the fourth quarter of 2016’; a recession was unavoidable.

The first pattern that generally emerges in a recession is that people cut back on their spending. With the uncertainty that goes hand in hand with a recession, people tend to focus on saving.

Unfortunately, because this is most people’s natural reaction, what they don’t realise is that it perpetuates a negative cycle. Less spending overall means less consumption, further weakening the economy. And so the cycle continues. During a recession, banks often cut interest rates to encourage borrowing and investing (an attempt to stimulate the economy). Taxes and government spending also change as the government tries to encourage economic growth through policy change. In the long term, however, this strategy could negatively affect the economy by increasing interest rates.

It’s important to be wise during a recession, but saving absolutely everything and not allowing yourself small spends like eating out once in awhile or buying the clothes you need will only perpetuate the situation. Of course, you need to do what you should have been doing anyway – drawing up and sticking to a budget so that you do not overspend. But there are a few other things you can do to weather the storm.

While you may think you are doing yourself or someone you care about a favour, agreeing to be a cosigner on a loan is not a good idea, especially in uncertain times. The reality is that if the borrower defaults on the payments, you will be liable. If it’s your loan, you may not get as good a rate as you would have gotten if you had taken it on solo.

When in the middle of a recession, it’s definitely not a good idea to take out extra debt – with the exception being a home loan, which is used to secure an asset. You should be trying to pay off your debt as soon as possible. Learn to be patient and buy only what you need. Things you want should wait until you have the money to do so.

While it may seem like a good idea to have your mortgage interest rate adapted to the lowered recession interest rates with an adjustable rate mortgage, it’s important to realise that the minute general interest rates rise, so will your mortgage. As Private Property states, ‘Sharp increases in interest rates may affect clients' ability to repay mortgage loans to such an extent that the financial institution has no other option but to repossess the properties concerned.’ It’s important at times like these to ensure that you play it safe with a fixed interest rate.

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