Is it Harder to Get a Loan in a Recession?

If you’re planning to acquire a new property soon, and you’ve already started your preliminary research, you might have noticed the impending signs of an economic downturn. However, that begs the question of, is it harder to get a loan in a recession? After all, with banks and lenders tightening their grip on cash, borrowers who are trying to secure a mortgage in this economy are bound to feel the pinch. Continue reading below as we’ve put together this article to explain what happens to loans during a recession and highlight the possible advantages.

What is a Recession?

For starters, we need to get a solid understanding of what a recession is economically. It’s normal for countries to experience a rise and fall in economic activities, but a recession is often distinct from a routine crunch because it is widespread and prolonged. If you want to get more technical, financial experts have a basic method to determine if a country is in recession, and that’s two consecutive quarters of negative growth in the country’s GDP. Individuals and businesses face more financial strain, causing most people to put a halt on acquiring new investments and debts.

As a result, people spend less, starting a vicious cycle where decreased consumer spending leads to lower business profits and rising unemployment. However, central banks try to respond by cutting interest rates, and Baltimore hard money lenders prioritize short-term loans to ensure loan repayment during a challenging economy.

What Happens to Loans During Recession?

Rise of Interest Rates

Despite central banks lowering interest rates, the lower benchmark rarely trickles down to commercial banks. In fact, it’s more common for lenders to raise rates on personal and business loans to cover the higher risks they incur during a recession. In other words, borrowers have to pay more for the same principal during an economic crunch. If you have a weak credit score, it can be even more difficult to secure a reasonable rate because your murky financial history doubles the risk and potentially your interest rate. Of course, that’s if you don’t get a straight-up denial.

Reduced Loan-to-Value Ratio

Another thing borrowers have to face during a recession is a lower loan-to-value ratio. For example, if you want to buy a house worth $100,000 in a normal economy, lenders may be willing to front you as high as 80% of the cost, which comes to $80,000. In comparison, lenders often use a lower LTV ratio during a recession to reduce their risk, and it can dip as low as 60% of the home’s value. At $60,000, that’s a significant difference of 20 grand. Hard money loan rates usually have a defined range depending on your loan provider and qualifications.

Stricter Lending Criteria

Besides making borrowing more expensive through higher interest rates and bigger down payments, recessions also make lenders adopt stricter criteria for lending. With cash tight, there’s more pressure to narrow down their limited resources to the most reputable borrowers. As a result, investors will need more documentation and a lower debt-to-income ratio to qualify. Even with a solid financial profile, you may still face delays that extend your project timeline due to the added scrutiny.

Are There Advantages to Borrowing During Recession?

Lower House Prices

With so many drawbacks to taking out a loan in the middle of a recession, are there any upsides? For borrowers who decide to secure a loan despite the economic challenges, they can expect to get their dream property at a discount. That gives you the opportunity to gain equity in the long run when the market eventually recovers.

Less Competition

Besides finding high-value properties at a steal, another advantage of borrowing during a recession is that there’s less competition. In a normal economy, more investors are on the prowl for a good deal, which increases demand and house prices. However, when there’s a crunch, there are also fewer buyers, which improves your chances of bagging the property during a bidding war. As a result, you also have more leverage to negotiate better and close a much more financially beneficial deal.

Conclusion

At the beginning of this article, we asked if it is harder to get a loan in a recession. As we’ve seen, for multiple reasons, the answer is yes. Thanks to the higher interest rates and lower LTV ratio, borrowing during a recession can be a lot more expensive. Not to mention, a stricter lending criterion reduces your chances of even securing a mortgage in the first place.

If you’re successful, you can have your pick of prime properties at discounted prices. Besides, the competition is also lighter, which gives you an edge during a bidding war and can help you negotiate better terms in the long run.