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Credit card rates could skyrocket if debt ceiling holds

by Peter Andrew
Credit card rates could skyrocket if debt ceiling holds

Do you know Libby and Connie Washington? They’re a very wealthy couple of sweet old sisters, and their credit score currently sits at 850, the best you can get.

Unfortunately, they also have a lot of obligations. They pay for their elderly relatives’ long-term care and medical bills. Their grandkids’ education is costing them a fortune. And just keeping their piece of prime real estate and their possessions secure is ruinously expensive.

All this was fine when times were good, but things have gotten tough recently, and Libby and Connie agreed they had to cut back. They settled on a household budget, but they’re still not happy with the size of their bills.

Credit score could take a hit

Of course, that’s not in itself a problem because their credit’s so good, but now they’re arguing over how they’re going to pay the credit card bills they charged all that spending to. Connie thinks the only way to keep their future expenditure under control is to tell their credit card companies where to stick their statements. Libby says that default and the consequent hit to their credit scores is going to make all their borrowing–past and future–ruinously more expensive.

Apologies for the clunky metaphor; you probably guessed in line one that Libby and Connie represent the divided U.S. Congress. And, of course, metaphors tend to be inherently flawed, and you won’t have too much trouble picking holes in this one. But it is true that the debt ceiling currently being debated is all about paying for spending that Congress has already approved, and little to do, at least directly, with future expenditure.

And it really could ruin America’s perfect “credit score.” Moody’s has already threatened to cut America’s current AAA rating, and as The Washington Times said on Saturday: “All agree the debt ceiling must be raised or the U.S. credit rating will be downgraded resulting in higher interest payments on the $14.5 trillion [already owed] and a downward spiral in the stock market again.”

Credit card rates at stake

It would be bad enough if it were only interest rates on government debt that were likely to rise in the event of default, which the U.S. Treasury believes will occur on August 2 absent an agreement to raise the ceiling. But consumer rates are tied to Federal rates, and everyone who owes on an adjustable- or variable-rate loan stands to pay significantly more for their borrowing.

That includes some mortgages, student loans, auto loans, personal loans, and home equity lines of credit. And it probably includes most credit card debt, which nowadays is usually lent on variable rates. As Sunday’s Washington Post observed: “Higher borrowing costs for the United States would mean higher interest rates on your credit cards, car and business loans and mortgages.”

So what’s likely to happen on August 2? The answer was summed up by Professor Matt Slaughter of Dartmouth’s Tuck School of Business: “Frankly, no one knows,” he told CNN Money on Saturday. “There’s no historical precedent for what happens if the U.S. defaults on part of its outstanding debt obligations.”

But the scenarios range from the vague (CBS News reckons: “Default likely would produce higher interest rates for consumers on mortgages, car loans and credit cards”) to the apocalyptic. Writing in The Detroit Free Press on Sunday, Mike Thompson predicted:

Failure to reach a debt ceiling agreement before the August 2 deadline would mean that legions of Social Security recipients would be without income, interest rates would shoot to the moon, America would plunge back into a deep recession, our military’s ability to protect the country would be placed in jeopardy and the global economy could crash and burn.

Credit card calculators help financial planning

Of course, if you have no variable-rate loans or credit card debt (and you don’t receive Federal benefits or have stocks and shares), you may escape the earliest impacts of default. But supposing you do. What might higher credit card rates mean to you?

At the time of writing, IndexCreditCards.com’s credit card rates monitor says that the average rate for consumer rewards cards stands at 17.09 percent. So let’s use some of the same website’s credit card calculators to model a possible scenario.

We’re going to assume that you’re paying that average rate, and that your household’s credit card debt stands at $7,394 (the average credit card debt as of February 2010). And, plucking a figure from the air, let’s assume that credit card rates rise over a period after August 2 by 5 percent (to 22.09 percent), which is hardly “shooting to the moon,” although nobody knows whether that figure’s too high or too low.

Credit card debt could get seriously expensive

If today you wanted to pay off your card balance within a year, you’d have to find $674.68 each month. If rates jump 5 percent the same monthly figure would be $692.36. Meanwhile, also over a year, the cost of servicing a debt of that size without paying it down could increase by $441.81.

Of course, it’s too early to panic. If you have faith in your elected representatives, you may believe the danger could still be averted. If you have faith in credit card companies, you may believe that they won’t find ways to maximize their revenues when sooner or later they hike rates. And, if you have faith in those, you might just as well count on getting out of trouble by finding a leprechaun to lead you to a pot of gold.

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