As you know, we’ve exceeded our $14.3 trillion debt ceiling (the largest amount of money we’re legally allowed to borrow) on May 16, 2011 – and if a resolution (do we raise the debt ceiling vs. reduce spending?) is not made by August 2nd (just five days from now), economic trouble awaits. Just like everyone has their own credit scores, the government has a credit score too – and if a deal isn’t reached to resolve the debt crisis, the rating agencies (Moody’s, Standard & Poor’s and Fitch) may downgrade the U.S. credit rating – we currently have a stellar credit rating, which is why we get the best interest rate on our country’s outstanding debt. But if the rating decreases, the U.S. will be paying more money on interest payments.
And it’s not just the government paying more money on interest – consumers too. Here’s how.
1. Credit Cards: Credit card interest rates will spike if the U.S. credit rating is lowered – since this all may cause an increase in the prime rate (which is structured off of the Fed funds rate determined by the Federal Reserve). And, you guessed it, most of the interest rates on our credit cards are based off of the prime rate.
According to Sallie Mae, 50% of college students have four or more credit cards – so an increase in rates would cost students more money!
2. Student Loans: Interest rates on student loans are also expected to increase if the credit rating is downgraded – student loans are based on the LIBOR rate, which is affected by Treasury yields (money that can be made on U.S. bonds) – if government bond/note rates rise, student loan rates will also rise. As for Federal student loans from the government, these rates are fixed and won’t be raised, unless Congress demands so.
On a separate issue relating to the debt ceiling saga, the plan being proposed by House Speaker John Boehner (R-OH) and House Majority Leader Harry Reid (D-NE) will impact both graduate and undergraduate student loans. As per the plan, after July 1, 2012, the government will not lend subsidized loans to graduate students. Subsidized loans are preferable, as opposed to unsubsidized loans, because under subsidized loans, the government pays the interest while you’re in school. The government will take this savings to finance the Pell Grant program, which is used to help low income undergraduate students receive grants.
According to the Congressional Budget Office (CBO), this proposal could cause $125 billion of graduate student loan money to be transferred from subsidized to unsubsidized over the next decade.
3. Retirement Accounts: A downgrade will likely cause the stock market to tank, which would obviously hurt your 401(k) plans and Roth IRAs. But don’t panic – it’ll look bad on paper, but over time, as the markets regain their value, you’ll be better off. Unless you need the money you have invested in stocks within a few months or a few years, stay calm and consider continuing your investment strategies (i.e. Dollar Cost Averaging).
[As originally posted on HelpSaveMyDollars.com)
Scott Gamm is a student at NYU’s Stern School of Business and founder of the personal finance website HelpSaveMyDollars.com. He has appeared on NBC’s TODAY, MSNBC, Fox Business Network, Fox News, ABC News and CBS. Follow Scott on Facebook.