What Does America’s Credit Downgrade Mean for You?

By Christopher Maag

There’s lots of bad news surrounding the announcement by Standard & Poor’s to downgrade the credit rating of the U.S. government. The decision will make it more expensive for the country to borrow money, adding to the national debt, and the announcement has thrown the stock market into a serious tizzy.

But here’s a surprise: For some consumers, the credit downgrade could actually be good news. People who save money, whether in the form of savings accounts, CD’s or Treasury bonds, could actually be benefit.

The bad news is that people who borrow lots of money could be hurt.

“Savers may be helped by this change,” says Cheryl Garrett, a financial expert and founder of Garrett Planning Network, a financial planning company based in Kansas.  “Borrowers are going to be negatively affected.”

Good News for Savers
Here’s how this works. When S&P announced it would downgrade the American government’s creditworthiness from AAA to AA+, it means the government will have to pay higher interest to investors buying Treasury bonds (since there’s a slightly higher risk than there was last week that those investors won’t get repaid).

That one change has lots of large and small effects downstream. Many large banks sit on large piles of Treasury notes, as well as gold and cash, because they are required to have some amount of hard reserves on hand as equity for all the credit they’ve extended. All of  a sudden, those Treasury notes are worth less now than they were last week, Garrett explains, because investors would rather buy the new bonds with higher yield than the old ones in banks’ vaults, which have lower interest rates.

In addition, banks borrow money from the Federal Reserve, and the lower credit rating will make that money more expensive to borrow. Meanwhile, banks will be forced to pay consumers somewhat higher interest rates on CD’s and savings accounts, Garrett says, because now those same consumers could earn more money buying Treasury bonds, so banks must raise their rates to compete.

All of that adds up to the silver lining of this story: If you have money saved up, or invested in super-stable things like CD’s and Treasury bonds (which have so little risk they’re seen as equivalents to savings), you probably will win out, in the form of slightly higher interest rates.

“If interest rates do go up that’s good for savers, because savers have been suffering with low interest rates for years,” says Gerri Detweiler, Credit.com’s consumer credit expert.

Bad News for Borrowers
 
Of course, the other side of higher interest rates is the effect they have on borrowers. Banks will have to spend more money to maintain their cash reserves, borrow from the government and obtain cash from consumers’ savings and CD accounts.

How will banks make all that money back? By charging more for loans, Garrett says.

“If a bank is under pressure to add reserves they may not have the ability or desire to lend out money when they’re trying to shore up their own balance sheets,” says Garrett. “It could mean some banks becoming much more conservative about their lending.”

[Related Article: How Would A Double-Dip Impact Credit Card Rates?]

Secured debts – loans backed by a real asset like a car or a home – could get more expensive over time. But unsecured loans, things like credit card debts that are backed only by a consumer’s promise to repay, could see the biggest interest rate increases, Garrett says.

“It’s going to be more expensive to borrow, especially debt that’s unsecured like credit card debt,” Garrett says.

Those interest rate hikes could happen without you knowing it, Detweiler warns. Under the CARD Act, credit card issuers must give card holders plenty of advance notice before raising rates.

One big exception, however, is they don’t have to notify you if the increase happens because the index to which the card’s rate is tied goes up. Many credit card interest rates are tied to the prime rate, which is the rate that banks charge their best clients. If the rating downgrade causes the prime rate to go up, that means credit card companies can increase your rates without telling you beforehand.

Which makes it more important than ever to read your monthly statement and make sure you know what your interest rate is.

“If the prime rate goes up, it’s very likely your credit card rate will go up to, and the issuers are not required to notify you,” Detweiler says.

[Featured Tool: Get your free Credit Report Card from Credit.com]

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