Government debt crisis will hurt your credit

With the debt ceiling deadline just days away, all eyes are on the government's ability to borrow money. But if the ceiling isn't lifted, it won't be just the government having problems taking out a loan; everyday Americans will likely encounter new costs and difficulties as well.

The worst-case scenario would be that the U.S., running out of cash on August 2, ends up defaulting on its outstanding loans. A default would affect the supply of money and of credit, says Keith Gumbinger of HSH, which collects mortgage and consumer loan information. An interruption in the flow of credit, beginning with Treasuries, could make it more difficult for consumers to get a loan, he says.

“Our biggest concern in the default scenario is not the interest rates — it’s restricted access to credit,” says Greg McBride, a senior financial analyst for Bankrate.com.

While the ensuing credit crunch would be similar to that of 2008, it wouldn’t be quite as catastrophic. And it would be brief, because most analysts believe that the U.S. would quickly find a fix and raise the debt ceiling.

A more likely scenario is that the U.S.'s credit rating would be downgraded — a development that, unfortunately, would be longer-lasting than that of a default and more difficult to reverse.

Without a long-term solution to address the budget deficit, the U.S. could see a credit downgrade even if the country avoids a default. A July 22 statement from credit rating agency Standard & Poor’s described a 50 percent chance of a downgrade in the next three months if Washington fails to achieve what the agency considers a “credible” solution to handle future budget deficits.

Moving from a AAA credit rating to a AA credit rating would bump up interest rates modestly, McBride says. Credit would still be available, but it would be more expensive.

Interest rates for mortgages could see an increase of an eighth to a half of a percent, Gumbinger says — small enough that it wouldn’t be a disaster for the real estate market. While people with fixed rate mortgages won’t be affected by rising interest rates, any increase would make refinancing seriously unattractive, and some new buyers could be hit with costs that are higher than expected.

The staying power of higher interest rates could be the real problem. A rise in interest rates could dry up business financing and consumer spending, exacerbating unemployment and pushing a troubled economy back into recession.

“The longer it drags on, the more damage it’s going to cause,” Gumbinger says. “For lack of a political solution, are we willing to wreck the economy again?”

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