How the Federal Debt Limit Affects Your Money, Credit Card Debt

Just like you have a spending limit on your credit card, the U.S. Federal Government has a spending limit known as the federal debt limit. Like a credit card spending limit, the U.S. debt limit essentially caps how much money the federal government can spend. In other words, once the debt limit is reached, new spending cannot be authorized.

Created by Congress in 1917, the debt limit, or ceiling, sets the maximum amount of outstanding federal debt the U.S. government can incur. 

In January 2023, January 19, 2023, to be exact, the U.S. essentially maxed out its ability to pay its bills when the federal debt reached its $31.4 trillion mandated debt limit. Thanks to some creative budgeting and money moves, Treasury Secretary Janet Yellen was able to continue to pay the United States’ bills, but this was only a temporary solution. 

Yellen has shared for several months that the treasury would run out of money to pay its bills as early as June 1, 2023, unless Congress raised the debt ceiling limit, aka increased its spending limit. Yellen stressed that if the debt ceiling isn’t raised, some bills would go unpaid, likely resulting in devastating economic consequences for consumers not only in the U.S. but around the globe.

“We have learned from past debt limit impasses that waiting until the last minute to suspend or increase the debt limit can cause serious harm to business and consumer confidence, raise short-term borrowing costs for taxpayers, and negatively impact the credit rating of the United States,” she said.

While everyone agrees that something must be done to ensure the U.S. can pay its bills, there is some disagreement on what is involved in raising the debt limit and if June 1 truly is a hard deadline for the debt limit to increase.

Pennsylvania Republican Rep. Brian Fitzpatrick opined the Treasury has some leeway past June 1 and is likely able to pay its bills until around June 15.

“The June 1st date was probably, according to Secretary Yellen, the earliest possible date,” he told CBS News, adding that “we do have enough cash flow” to “pay the interest on our debt.”

“We’re going start to see the state tax revenues come in the second week of June, so I think we’re OK on that,” Fitzpatrick said.

On May 26, 2023, Yellen herself acknowledged that lawmakers had until June 5 to reach a deal before the U.S. would default on its debt.

Regardless of whether the U.S. would be unable to pay their bills on June 1 or June 15, everyone agrees this is a serious problem with serious financial consequences for just about everyone.

“We’d be in uncharted territory, and the consequences to the U.S. economy would be highly uncertain and could be quite averse,” Federal Reserve Chairman Jerome Powell said, noting that nearly every corner of the finance world relies on U.S. government yields as a benchmark. 

How Common Is Raising the Debt Ceiling?

The need to increase the debt ceiling has become a more frequent issue since 2001 because the U.S. government has run a deficit averaging nearly $1 trillion every year since then. In other words, the U.S. federal government has spent around $1 trillion more money than it receives in taxes and other revenue every year since 2001.

Raising the debt ceiling may be a contentious political issue now, but it hasn’t always been this way. For decades, raising the debt ceiling was a relatively routine procedure for Congress, according to the Center on Foreign Relations. Whenever the Treasury Department could no longer pay the government’s bills, Congress acted quickly and sometimes unanimously to increase the limit on what it could borrow. 

Since 1960, Congress has acted 78 separate times to permanently raise, temporarily extend or revise the definition of the debt limit – 49 times under Republican presidents and 29 times under Democratic presidents. Most recently, the debt ceiling was raised in 2021.

Addressing the debt ceiling doesn’t come with a cost to taxpayers or bring new spending commitments. Rather, it allows the government to continue financing the spending and obligations previous Congresses and presidents already committed to.

Since 1789, the U.S. has never defaulted on its debt payments, but in 2011, the U.S. came close due to partisan battles. 

In 2011, Congress reached a deal to raise the debt ceiling two days before the Treasury estimated it would run out of money. However, the close-to-the-deadline deal had a negative impact on the U.S. economy. The credit rating agency S&P Global Ratings downgraded the U.S.’s creditworthiness for the first and only time ever. And according to the Government Accountability Office, which serves as the federal auditor, the delay in reaching a deal led to increased interest rates and borrowing costs that ultimately cost consumers $1.3 billion that year alone.

Yellen has warned that without increasing the debt limit, the U.S. would likely be unable to pay its bills. A national default would destroy jobs and businesses and leave millions of families who rely on federal government payments to “likely go unpaid,” including some 67 million Social Security beneficiaries, along with veterans, and military families. There would also be an economic ripple effect around the world, Yellen noted. 

“The United States has a history of paying its bills on time,” she said. “That’s what the world wants to see a continued commitment to do that. It’s what underlies U.S. Treasury securities as the safest investment on the planet. And it’s not an acceptable situation for us to be unable to pay our bills.”

How the Federal Debt Limit Affects Your Money, Credit Card Debt

Although the U.S. is not expected to default on its bills, with most economists and political analysts agreeing that a deal to increase the debt ceiling, at least temporarily, will happen before the June 1 deadline, the close-to-the-wire deal could still have an impact on the economy.

“Investors can’t help but feel nervous,” wrote Danni Hewson, head of financial analysis for AJ Bell. “The last time these talks got down to the wire, markets plummeted, and the country’s borrowing costs shot up. Even if the deadlock is broken in time to prevent the U.S. defaulting on its debt, the uncertainty is destabilizing, particularly when the economy is already looking a little vulnerable.”

Wealth Management Advisor and CEO of Taylor Financial, Adam Taylor, agreed a deal will likely be reached in time but said this is still a good time to think about your financial security, specifically any debt you may have. That’s because failure to raise the debt limit in time would likely lead to higher interest rates, including on credit cards. Higher interest rates would be particularly difficult for consumers who already have historic levels of credit card debt thanks to record-high credit card interest rates, currently averaging between 21 and 24 percent.

Mortgage rates could also surge to 8.4 percent by September 2023, up from 6.9 percent in May 2023, according to Zillow. The increase in mortgage rates means the average mortgage payment would be 22 percent more expensive, adding $130,000 to the cost of an average 30-year mortgage, which would likely “freeze” the market, the real estate company said.

Making payments toward your debt would increasingly be difficult for those who receive Social Security benefits and/or are government workers, including those in the military.

Some 70 million Social Security recipients would likely be among the first to feel the brunt of the Treasury running out of money, says Wendy Edelberg, director of The Hamilton Project at the Brookings Institution. That’s because Social Security benefits would likely be withheld in order to allow the government to pay other bills.

“If indeed the debt ceiling bind continues, my guess is that they will prioritize paying interest on the debt and put off paying Social Security,” Edelberg said. “Just as if you have a mortgage payment and a car payment, you will move heaven and earth to pay that first and put off paying off other debts, like credit cards or a loan from your brother.”

Once the spending limit is raised, beneficiaries will receive any delayed payments, but in the meantime, a debt standoff poses a significant risk to their monthly income and well-being.

More than 2 million federal civilian workers and around 1.4 million active-duty military members, plus federal contractors, would also likely not get paid for some time if the U.S. defaults. However, many of these employees would still be expected to work.

Government workers would have to show up for their jobs, but they may not get their paychecks in full, on time, or both, Edelberg noted. As with Social Security benefits, the government would catch up on the back pay once spending limits were increased, but there’s no telling how long that process would take.

If you’re counting on your 401k or stock market investments to carry you through any sort of temporary pause in your paycheck, think again. If the U.S. defaults or has its credit rating downgraded, the stock market could fall by 45 percent, which would affect retirement savings accounts for many Americans. 

This would impact Americans’ abilities to afford basic necessities as well as make payments on credit card debt, auto loans, and mortgages, especially since interest rates would likely increase beyond the increases enacted by the Federal Reserve. For businesses, a dramatic increase in interest rates may affect their ability to employ and hire hundreds of thousands of Americans. In other words, there’s also likely to be an impact on the job market. 

The Congressional Budget Office and the Treasury Department projected on May 3 that if the government doesn’t pay its bills for even a week, 500,000 Americans would likely lose their jobs.

Again, most economists believe that if the June 1 deadline comes without a deal to increase the debt limit and the U.S. does default on its payments, many believe that the debt ceiling would be raised in a few days to minimize any impact on the economy and American consumers. 

How Can You Financially Prepare for a U.S. Default?

“We’re advising people to prepare for a potential default as you would for an impending recession,” says Anna Helhoski of NerdWallet.

1. Start Building an Emergency Fund

If you haven’t been setting money aside in an emergency fund, now is the time to start saving, even if all you can afford to set aside is $50. That means tamping down on excess spending, making a budget, and shoring up emergency savings to cover at least three months of living expenses.

“Now is the time to harbor your resources. Hold back on your discretionary spending. Avoid that extra restaurant meal until this situation is resolved,” said David Wilcox, director of U.S. Economic Research of Bloomberg Economics.

2. Reduce Credit Card Debt

A default could increase interest rates making it more difficult to pay off high-interest credit card debt. Make paying off high-interest credit cards a priority and consider working with a nonprofit credit counseling service like DebtWave Credit Counseling, which can lower your interest rates and monthly payments, allowing more of your money to go toward your debt instead of interest.

3. Act Fast or Postpone Big Purchases

If you’re in the market for a new car or are buying a home, consider closing your deal sooner than later or postponing until after a debt limit deal is reached unless you can ensure your interest rate is locked in. What you can afford today may be well beyond reach in a matter of weeks if mortgage rates rise as expected.

If higher interest rates have you struggling to pay down high-interest credit cards, consider a complimentary one-on-one financial analysis with one of DebtWave Credit Counseling’s certified credit counselors, or start your journey to financial freedom online.

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