The impact on your wallet of the Standard & Poor’s downgrade of the nation’s credit rating is similar to what would happen if your own credit score declined: The cost of borrowing money is likely to go up. Here are five things to keep in mind as financial markets respond to this historic event.
1. Uncle Sam’s interest rate may rise.
S&P is one of three major rating agencies that assess the riskiness of large institutions such as corporations and governments. The downgrade reflects a lack of confidence in the U.S. government to pay its debts over time. Riskier countries have to pay higher interest rates, just as riskier consumers do. S&P’s decision rocked the United States — and the world — because the nation has generally been considered one of the safest investments around.
2. If the government pays more, you pay more.
The interest rate the United States pays on its short-term loans is determined by the market for Treasury bills. The downgrade could increase the yields on those bonds, forcing the government to spend more to borrow the same amount of money. Many consumer loans, such as credit cards and mortgages, are linked to the yield on Treasuries and therefore would also rise.
3. Not everything will change.
Many major consumer loans have fixed interest rates that won’t change even if the cost of borrowing rises for the federal government. Far-reaching changes to the credit card industry that took effect last year prohibit lenders from changing their interest rates without giving at least 45 days notice in most cases. They also won’t be able to increase the rate on purchases you’ve already made, only new ones. But if you want a loan for a new car or college tuition, for example, be prepared for higher rates. In addition, some credit cards and home equity loans have variable interest rates that can fluctuate with the yield on Treasuries. Check your loan agreement to see what type of rate you have.
4. What’s the worst-case scenario for me?
John Ulzheimer, president of consumer education for SmartCredit.com, thinks the downgrade could force some homeowners to default on a portion of their mortgages, exacerbating the housing crisis. During the economic boom, many people financed their homes with two loans: a standard mortgage and a special home equity line of credit. These HELOCS require borrowers to pay only the interest on the loan, and the rate varies each month. If there is a significant increase, some homeowners may not be able to make payments.
5. What’s the worst-case scenario for Uncle Sam?
The S&P downgrade is likely to be a blow to the economy. The real pain won’t be felt unless the two other ratings agencies, Moody’s and Fitch, follow suit. Last week, the companies said they still believe the United States deserves the highest credit rating — but they warned that could change. To hold on to its credit rating, the country must reduce its debt and stabilize the economy, the firms said.