Could Your Finances Handle a Pay Cut?

by Miranda Marquit · 5 comments

Pay is no longer assured no matter what your job is these days, as more and more people are experiencing pay cuts. Whether your hours are reduced, or whether you lose your job and have to start somewhere else for a smaller salary, pay cuts are increasingly a reality. And, in some cases, you might even want a pay cut so you can achieve other goals.

No matter why you end up with reduced income, the important thing is to make sure that your finances will survive if a pay cut happens. And, of course, if you are thinking of dropping to part-time to pursue other opportunities, or if you want to cut back on your hours in order to spend more time with your family, you will need to make sure your finances can handle the change, and maybe even downsize your lifestyle. Here are some things to do now to prepare for a pay cut later:

Pay Down Debt

This always seems to be at the top of any financial preparedness list – and for good reason. When you have obligations hanging over your head, your money is not your own. It’s money that’s already spoken for. If you take a pay cut, you end up with a larger portion of your income going to debt obligations, rather than paying for your day-to-day expenses. Pay down debt as much as you can, and you’ll be in a better position if you make less.

Sock Away Extra While You Can

Don’t blow it all if you are earning good money now. Plan ahead instead by setting money aside while you are making it. Bank your extra money in a high yield savings account or some other liquid location. That way, you’ll be able to build up a stockpile of cash to draw on later. Back in my journalism school days, I had a professor who said it was important to have “F-U Money” so that if you decided you needed to leave, you could. While there’s nothing wrong with spending your money on fun stuff, don’t spend it all. That way, you’ll have have the ability handle a pay cut a little better.

Don’t Borrow to Your Limit

When my husband and I were house shopping back in the fall of 2007, we had lenders willing to approve us for what amounted to a monthly payment of 40% of our income. We could have done it. We could even buy a house with a payment amounting to 1/3 of our monthly income, keeping with the popular rule of thumb. However, we wanted some breathing room. When we bought, our payment was roughly 1/4 of our income. Now, all of our housing costs are less than 1/5 of our income. If we have to take a pay cut, it will take a true financial catastrophe to make our home unaffordable.

The same principle can be applied to car purchases and other major borrowing decisions. Just because you are approved for a loan, and just because you can afford the payment now, doesn’t mean you should go for it. If you have to stretch to “afford” it, or if the payments are just within the realm of comfort, you could see serious problems if your pay is cut.

Do an evaluation of your financial situation right now, and determine if your finances could handle an income reduction. If they can’t, it’s time to re-evaluate your habits.

You can never be too prepared for the unexpected.

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{ read the comments below or add one }

  • I think the third piece of advice is particularly valuable. Just because you are approved for a mortgage or car loan of a certain amount doesn’t mean that you should reflexively borrow that much. You should take a careful look at your needs and then buy a house or car that’s as inexpensive as possible that meets your needs.

    I see many people who had credit continually granted to them and they have a highly leveraged lifestyle. One smaller-than-normal commission check or bonus, or a reduction in salary can spell the end of that lifestyle very quickly and often leads to collections lawsuits, garnishment, and sometimes bankruptcy.

  • Marbella says:

    I’ve always lived by the principle not to borrow for a car, holiday, travel, furniture, etc. but only had a little loan when I bought the house, not more than 50% of house prices and it may only be 20% of my income for interest rates and down payments. You must save in the high economic time to keep in reserve at the recession.

  • My husband and I planned a year ahead for the loss of my income when we had our son. We rearranged our budget so that we were living entirely on his salary (which would be doing when I stayed home) and used my salary to pay off a home equity loan. This meant that by the time our son was born, our only non-mortgage debt was gone and we could easily afford to go down to one income.

  • Sun says:

    Many couples that are planning for a child run the single income scenario. If you have debt, you might consider paying off debt exclusively with one salary and use the other salary to live on. If you plan, you could end up with a surplus before you plan for your first child.

    > if you are thinking of dropping to part-time to pursue other opportunities

    Why not prove your side business works before you drop to part-time? I find it very risky to start a new venture without knowing how much you actually make versus what you project.

  • Jean says:

    I try to limit my expenses as far as possible. Despite careful budget planning before every month where I leave a little money aside for unplanned expenses, I frequently find myself on the edge of what I can safely spend without affecting my savings. I think at the moment, I can only afford a month of being laid off and living entirely on what I make online.

    -Jean

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