Coping With An Economic Downturn

Could you cope with a further rise in interest rates or a short-term loss of income? The key is to be prepared.

A friend of mine rents out some small business premises connected with the leisure industry. When the quarterly rent cheque arrived a few days ago, the tenant apologised profusely for post-dating it by a month because his 'winter contingency fund' had been eroded to a greater degree than he had anticipated. Bad weather and an accountancy error apparently.

Fortunately, my friend doesn't rely on the rental income to pay his own bills so he can wait a month for his money. Besides, he's got a winter contingency fund of his own. And at least the tenant sent the cheque on time with an explanation instead of hiding away until he got chased up by his landlord.

It was strange when discussing this with the landlord because I had that morning been reading the Financial Service's Authority's latest Financial Risk Outlook. In it the City watchdog urged the financial services industry to 'stress-test' their businesses in preparation for an increasing risk that the global economy will become more 'unsettled'. In other words, businesses should make sure they could cope with a potential downturn.

The report advised consumers to do the same saying that there is 'a real concern' that many of them are over-confident about the future and would be ill prepared if economic conditions were to deteriorate. There are already growing signs of consumer distress, such as record levels of insolvencies, late payments on credit cards and a rise in mortgage-possession orders.

Interest rates have risen three times from 4.5% to 5.25% since last August -- an increase of 17%. If you've recently fixed your mortgage rate, these rate rises won't have an impact on your biggest expense. But anyone on a variable rate or whose fixed rate term is coming to an end could be in for a shock if, as is generally anticipated, the Bank of England hikes up the base rate even further.

According to Moneyfacts, some lenders are reporting that since the initial base rate rise last August more people are now opting for longer fixed rate deals. And that's probably the best solution if your mortgage payments are already high in proportion to your income.

In the meantime, put any extra money you can find into an easy access savings account so that you too have a 'winter contingency fund' to fall back on. Just make it a healthy contingency fund! Aim for at least three months salary and choose an account that pays a decent rate of interest. If economic conditions do get worse, at least you'll be prepared like the landlord mentioned above.

More: Is Switching Mortgage A Good Idea For You?