Overall I’m optimistic about the way the economy is moving. Taxes are the lowest they have been in generations, unemployment is at a 50 year low, interest rates are relatively low, and inflation is below 2%. These are all good things. Despite how optimistic I am, I also am a realist and an opportunist. The good times can’t go on forever and we are 10 years into what is now the longest economic expansion in US history.
Why Prepare For The Next Recession:
I remember during the worst part of the 2008-2009 recession (which started here in Michigan in 2001) being in a tight spot. Mrs. C. and I earned a combined $22,000 in 2008 and depleted all of our savings between living expenses and buying an investment property that we didn’t have enough capital and credit to fix and flip. Our son was also born in 2008 adding to the economic stress. I know it’s irrational, but I am fearful of returning to a similar situation again. We had no access to cash and our only net worth was a few grand in a retirement account and the down payment that was stuck in our primary residence. Making new investments while prices were low wasn’t even on the radar because we were focused on just keeping our heads above water.
“Be fearful when others are greedy and be greedy when others are fearful”.
I think right now is an appropriate time to be fearful. I’m taking the following steps to shore up my finances in case of another recession. By the way all of these action items work to strengthen my position, so if a recession doesn’t happen I still win. I have these sorted by order of importance.
How To Prepare For The Next Recession:
Maintaining An Emergency Fund:
Our 6 to 9 month cash emergency fund is being maintained. Despite our goals of paying off our house and expanding our rental business this money is not being touched. Having a deep cash reserve is extremely important during a recession. This should be the number 1 priority for anyone reading this, Stack some cash! I was allowing myself to look at tax auction properties that we would need to pay cash for, although the deals looked really good, the risk isn’t worth it and we are going to maintain this level of cash.
Refinancing Our Mortgage(s):
Mortgage rates have been dropping recently and it is a great time to refinance. I have 2 mortgages that I have paid down substantially over the last 5 to 10 years and I recently incurred roughly $50,000 of heloc debt purchasing and rehabbing 2 rental houses. Our heloc has a 1.5% minimum payment, which is $750. We owe $52,000 on our primary residence with a payment of $570 and we owe $17,000 on our first rental house with a $340 payment. Total payments of $1,660.
We are refinancing our first rental to 75% equity on a $95,000 valuation. This new loan at $71,250 will pay off the remaining $17,000 loan, our entire heloc and cover the closing costs. This cuts our payments for the heloc and this property in half from $1,090 to $550.
We looked into refinancing our primary residence to a 5/1 ARM at 3.5%, but the closing costs prevented this from making sense. The lender offered a “no closing cost” loan, however when building points into the loan the interest rate skyrocketed to 6.375%. The numbers just didn’t work. We plan on having the house paid off in under 18 months, which is why I thought buying negative points would work. The main benefit to this refinance was to drop our monthly payment from $570 to $250. If we hit hard times reducing this payment would be a big help.
Increasing Rental Income:
We currently have 3 rental properties, with 1 of them being vacant. This will be ready to rent in a month. Once this is rented out our cash flow from rental activities should be greater than $1,000 a month. This provides an excellent income diversification.
We plan to buy 2 more rentals in the near future. We will use our heloc to pay cash for both, then do a cash out refi 6 months later. This should be roughly $40,000 on a 15 year mortgage with a $300 a month payment. These 2 houses combined should net another $1,000 a month in income after mortgage/taxes/insurance/maintenance.
Paying Off Our House:
My work schedule for the rest of this year is already set and we should be able to pay down $15,000 more on our house by the end of the year. As long as 2020 goes well we should have it paid off at the end of 2020, or at least really darn close. Having our house fully paid off at the end of 2020 will reduce our total payments by $570 per month and our total debt by almost $50,000.
Switching To Roths:
We are switching our overall investment strategy from tax deferred accounts to Roth accounts. This will give us a higher tax bite, but will allow us to if needed withdrawal contributions tax and penalty free. There are other advantages to switching to Roths, most notably for generational wealth building.
Paying Connecticut Taxes:
It looks like I will become a full time employee of one of the companies I work for, which will include being paid a stipend while not working on an active project. In the event that this does not go through I have been paying into Connecticut taxes through my other employer (who is based in Connecticut ) and am eligible for Connecticut unemployment benefits. This is a pretty big deal because Connecticut unemployment is $631 per week, plus $15 per dependent for 26 weeks. Michigan unemployment is $362 max per week for 20 weeks max. If a recession hits and I am off work longer than normal, this makes a big difference. Like I said, most likely I won’t need to file another unemployment claim, but if I do I am ready. A maximum benefit of $17,186 over $7,240 makes quite the difference.
Increasing our HELOC:
During the great recession hundreds of thousands of helocs were frozen. If a bank freezes your heloc you can not withdrawal any more money. These freezes were typically done because their models showed they were overextended on that asset. If your house was worth $200,000 and you had a first mortgage at $130,000 they may have given a $30,000 heloc for 80% LTV. If their models showed your house dropped in value 20%, and is only worth $160,000, then the most they should have at risk is $128,000. With the first mortgage being worth more than that, the line must be frozen.
With an expected $0 first mortgage on our primary residence at the start of 2021, we will seek to increase our heloc to 80% LTV, which would be around $160,000 at it’s current $200,000 value. We would also switch our heloc from the current 1.5% minimum payment to interest only for the first 10 years, which most helocs are. If they see my property has dropped 20% in value they may cut my heloc down, from $160,000 to $120,000 but would most likely not eliminate it. Having this large source of available capital during a recession is desirable. Typically banks and credit unions charge nothing to open a heloc. My credit union does charge a $250 fee if I cancel it less than 2 years from opening it.
With the Federal Reserve indicating that it is beginning an easing process with future rate cuts to come, heloc rates will drop in tandem with the Federal Funds rate. We will most likely only use our heloc for short term financing of positive cash flowing rental properties.
Be Indispensable At Work:
Easier said than done right? As much as I would like to believe I am there, in all honesty we are all replaceable. Maintaining an income will be key during the next recession. I routinely volunteer for extra assignments and responsibility and strive to be well liked by all the stakeholders that are around me. The largest employment risk for me personally is not being individually fired, but either our company losing the contract I work on or the plant shutting down for economic reasons. I work as a contractor at nuclear plants all around the country and it has been unnerving seeing the total number of plant closings over the past few years. With that being said, my home plant is a 2 unit plant that has invested over a billion dollars in positioning itself for the next 35 years, so they are less likely to close than some other plants.
Expanding Income Sources:
Mrs. C. quit her job last month, which is something we’ve had our eyes on for a while. We don’t anticipate her needing to go back to work, but it is an option if we are hit hard by a recession. She has signed up for Uber and Shipt and is getting her feet wet with both soon to see if they are a good fit for a flexible side income.
I am keeping in contact with my other employers and recruiters to make sure I don’t fall off the radar by taking a full time position with one company. Keeping these contacts fresh is extremely important in the event of a job loss.
Our expenses are already pretty low, but there is always room for improvement. We have been spending just under $50,000 a year with a family of 6. We currently have 2 kids that have been through orthodontic work. We just finished paying off kid #2s braces at $170 a month, and Kid #1’s payments at $135 a month will finish at the end of 2020. With Mrs. C. off work she will do some more meal planning and should be able to save us a couple hundred a month on groceries and miscellaneous expenses. Between braces, groceries, and miscellaneous we should be able to reduce our expenses by $500 per month by the end of next year, saving $6,000 a year and reducing total spending to under $44,000 a year. Add in our house payment dropping from $570 to $0 and our yearly spending drops to $37,000 for 2021.
Rebalance Our Portfolio:
I haven’t done this in 2 years and during this time our allocations have drifted from what we originally intended. We are rebalancing now.
Examining Tax Scenarios:
I do this a lot. I built a spreadsheet that allows me to compare several different tax scenarios side by side. I have not updated it for 2019 numbers yet, but it is still pretty darn close. With a reduction in total income comes an increase in tax breaks, ranging from refundable child tax credits to the retirement savers tax credit, and the earned income tax credit. With rental income we can’t get the EIC, but the retirement savers tax credit and the child tax credit are substantial if our income drops. Being able to contribute at least $4,000 a year to retirement accounts allows us to get up to a $2,000 tax credit if our income is low enough.
Recessions are tough, especially when you lose your job. You see your net worth drop substantially and in the media all you see is doom and gloom. Keeping a long term outlook is important during a recession, which is why the above steps are so important. All of those steps will allow me to keep my head above the water and focus on 5 years, 10 years, 20 years down the road rather than this week and this month.
The best time to invest is during a recession and with a strong balance sheet and continued employment this is magnified. This is especially true of investing in rental property with interest rates at historic lows. Stocks were on sale and houses were on sale in 2008 and 2009, both things I plan on buying during the next recession.
What are you doing to prepare for the next recession? What did I miss?