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What the federal budget crisis and possible default may mean for consumers

The debate in Washington over the federal budget crisis and possible default has given rise to all sorts of consumer fears of doomsday scenarios. Missed Social Security payments. Spikes in interest rates. Draconian cuts in government services. But the most likely outcome is that the nation's credit rating will be downgraded a notch from its sterling triple A rating. Here are some potential consequences for consumers:

Higher lending rates

Americans will pay more on credit card debt. Home and car loan interest rates will rise, too. Numerous economic forecasters predict an immediate rate increase of at least 1.5 percentage points on consumer interest — adding nearly $20,000 to the cost a $175,000, 30-year home mortgage. Lots of U.S. lending rates are based at least in part on the interest rates on U.S. government bonds. If there's a ratings downgrade and U.S. bond yields rise, that will spill over eventually into lending rates. But as Greg McBride, a senior financial analyst at Bankrate.com, said, lenders must give borrowers at least 45 days' notice before raising their credit card interest rate, and can only raise it on new balances.

Plunging stock market

Financial services firm Janney Montgomery Scott says a default could prompt a 6.3 percent decline in the S&P 500 over three months, a blow to holders of 401(k)s, money market funds, bond funds or individual stocks. "Once a plan is in place, we would expect the markets to return to normal, and for investors to focus on more fundamental issues like long-term earnings growth," said Gus Sauter, chief investment officer at Vanguard. "That said, it's simply not possible to gauge precisely how the equity and fixed income markets would react ... so the best course of action is to ignore the headlines and maintain a long-term approach."

Possible cuts to benefits

Future payments from Social Security, Medicare and Medicaid are uncertain. Treasury Secretary Timothy Geithner says flatly that a broad range of government payments would have to be stopped. Will it happen? That's up to President Barack Obama to decide. But reduced or delayed benefits are definite possibilities. Geithner says unemployment insurance might also have to be delayed or reduced. The Office of the Comptroller of the Currency said there may be disruptions in the timing of various federal benefit payments that could cause some customers to inadvertently overdraw their checking accounts, and "We will encourage national banks to work with their customers and exercise judgment related to overdraft or penalty fees."

Student loans

Federal student loans would be frozen. An estimated $8.8 billion in Pell Grants for the coming school year would not be paid in August and September. The interest rates on most private student loans are pegged to the London Interbank Offered Rate, or Libor, which is influenced by Treasury yields. So if the yields on government securities rise, student loan rates could rise as well, said Mark Kantrowitz, publisher of the FinAid and Fastweb websites. . The deficit reduction plan, which is likely to cut education spending, could have a broader effect on student lending.

New York Times, Houston Chronicle, McClatchy Tribune News Service

What the federal budget crisis and possible default may mean for consumers 07/27/11 [Last modified: Thursday, July 28, 2011 7:58am]
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