How a U.S. Debt Default Could Hit Your Finances

Getty ImagesBy Sharon Epperson

If Washington fails to agree on legislation to raise the debt ceiling and the United States defaults on its debt obligations, it would be devastating to the U.S. economy. Putting into question the full faith and credit of the U.S. Treasury could send financial markets, not only here but likely around the world, into a tailspin.

Though average Americans have no control over whether that will happen, it could have serious consequences for your personal finances.

The fact is you don’t know what will happen, and many analysts and traders on Wall Street are adamant that Washington lawmakers will not allow the United States to default. So in the meantime, it is important to keep calm and focus on the aspects of your financial life that you can control.

Pay Down Your Own Debts

If the U.S. defaults and its credit rating suffers, it may have to offer higher interest rates to lure investors to buy U.S. Treasury securities. If the government’s borrowing costs go up, borrowing costs for some homeowners and credit card holders may go up as well.

If you have an adjustable-rate mortgage, the rate will eventually go up and your payment may increase hundreds of dollars a month. What can you do? You could make an extra payment now — as much as you can comfortably afford. So while your rate will still go up, you’ll be paying that interest on a smaller amount of the overall pie. Credit card rates will increase too. Pay off your credit card debt. It’s never a good idea to carry a balance from one billing cycle to the next, but it will be especially painful if rates — which are already more than 15 percent on average — move even higher.

Don’t Keep Money That You’ll Need in 5 Years or Less in Stocks

The S&P 500 plunged 17 percent after the last debt limit stalemate in August 2011 — and that crisis was averted in the 11th hour. Still, it took about seven months for the stock market to recover after that. If the U.S. actually breaches the debt ceiling deadline this time, the impact on stocks and equity mutual funds could be even more devastating. But that doesn’t mean you should rush to sell.

Most financial advisers will tell you that the markets will recover, eventually. For most Americans, stocks should be long-term investments. If you need the money that you’ve put in the stock market in the next year or even five years, it should be in cash, not stocks.

Rebalance and Diversify Your Retirement Portfolio

If the debt ceiling stalemate doesn’t end, retirement accounts could be very hard hit. A report out Tuesday from the American Society of Pension Professionals and Actuaries predicts private pension plans will take a hit of more than $2 trillion (losing in excess of 20 percent of their value) if the financial markets tumble as a result of a default.

This is a very scary proposition for seniors, but also should be a wake-up call for every investor. Reallocate retirement-plan assets to make sure they are well-diversified among many different types of investments.

Put Your Best Foot Forward on the Job

Hiring could come to a standstill if the U.S. is in the midst of another financial crisis. An uncertain political and economic climate could stifle job growth. Your job, your career, is likely your biggest financial asset.

When the economy is in crisis, a good job is even harder to come by. You don’t want to lose it. Continue to make yourself as professionally marketable as possible.

Cut Spending to Build Up Your Cash Savings

Another major factor that you can control is the amount of cash you keep on hand. Don’t arbitrarily sell all of your investments or cash out of your retirement or college savings plans. Work on building the cash cushion. So many Americans don’t have one. You may not want to think about the emergencies that often necessitate having this money on hand, such as unforeseen medical bills, housing repairs or job loss.

You may think you don’t have any extra money to spare to put in your “rainy day” fund. But you have to find some money somewhere. Figure out what expenses you can cut and save those dollars. Start by saving up to cover just one month worth of expenses, then increase your savings to three months or six months. Ideally, you may want to have a year’s worth of cash in the bank to cover your daily household expenses.

Again, no one knows for sure if the United States would default, but taking these steps now to shore up your personal finances should take some anxiety out of the debt ceiling countdown.

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