Mood of the Market
Mood of the Market
Americans waited with bated breath on our congressional leadership to resolve the debt ceiling crisis. At the 11th hour, a deal was struck to cut spending and raise the nation's debt ceiling, avoiding the potential that the U.S. would default on at least some of its obligations.
But the deal didn't provide new tax revenue, and the spending cuts it identified fell short of what analysts with the ratings agency Standard & Poor's thought was needed for the country to begin getting a handle on the national debt. On Aug. 5, Standard & Poor's downgraded the U.S.'s AAA long-term credit rating to AA+ -- a historic first.
Paradoxically, Treasury yields and mortgage rates plummeted in the wake of the decision, as panicked investors moved money out of global stock markets and into the relative safety of U.S. government bonds and securities that fund most mortgage lending.
But in the long run, the government's borrowing costs -- and everyone else's -- may very well increase. If investors share the view of analysts at Standard & Poor's -- that achieving a government spending plan that not only contains growth in public spending but also raises revenue "will remain a contentious and fitful process" -- Treasurys could fall out of favor with investors. That would push Treasury yields up, and rates on mortgages, credit cards and other loans would be likely to follow.
Hopefully, one bright side of this debt drama will be to shock the nation into deficit-reducing action. Another silver lining? There are three key lessons we can all take away from the nation's credit downgrade and apply to our own personal finances:
1. Don't flirt with late payments. America did not actually default on any of its debt -- not even a single payment was missed or late -- and it still took a credit hit.
Many individual consumers also flirt with late payments on their accounts, trying to take advantage of the 30 days after a payment is due that a creditor must wait to report the account delinquent to the credit bureaus, or otherwise missing a payment here or there. You're only human, right? And how much harm could a day or two do, you might wonder?
Credit card companies have been on a contract-revising tear lately, and some credit card companies now have the right to jack up your 6 percent interest rate to nearly 30 percent if you make your payment even one day late. Also, without a system for paying things on time, every time, it becomes much easier for a bill to slip through the cracks, resulting in an actual 30-day-late mark on your credit report. While neither of these outcomes is $100 billion bad, they are both undesirable.
2. Credit isn't everything -- unless you need it. Through having challenged credit or just finding credit difficult to get these last few years, many consumers have discovered that their lives and their financial decision-making fundamentally improve when they can't use credit. I know I personally have stopped using credit altogether since the recession hit, and have, as a result, saved tens of thousands of dollars I would have spent otherwise. One way I've done this is by simply saving and paying for things in cash, like my car, at much lower prices than I would have spent if I were going to finance them. I've also simply paid many accounts entirely off, out of a conscious decision to eliminate all debt, rather than trying to keep accounts going the way I would have if I were really concerned about maxing my credit score out.
However, if you're gearing up to make a large purchase on credit -- like a home -- the difference between a good credit score and an OK one can be the difference of many thousands of dollars in increased interest rates. And that can be the difference between being able to afford a home with the square feet or in the neighborhood you like, and not.
So, if you even think you'll be buying a home or a car in the near future, be conscious about all your financial moves and get educated about their likely impact on your credit score before you make them. Sometimes, things you think would bring your score up have a surprising effect -- your best bet is to connect with a mortgage broker as early as possible so you can have months or years to polish up your credit score, and an adviser on tap to consult before you pay something off or close out any accounts.
If you've decided to forgo credit purchases for the foreseeable future, shift your focus to setting and achieving financial goals such as getting out of debt, stuffing your cash cushion with more financial feathers or investing for retirement.
3. The less debt, the better. The ultimate reason behind the U.S. credit downgrade was that the rating agency closely watched what happened in the debt ceiling debate. The debt ceiling compromise will cut about $2 trillion in spending over 10 years. But without additional spending cuts (opposed by Democrats) and tax increases (opposed by Republicans), Standard & Poor's estimates that government debt will still continue to rise, from an estimated 74 percent of gross domestic product at the end of 2011 to 79 percent in 2015 and 85 percent by 2021.
Apparently, the days when the name of the game was to take as much debt as you can pay for month to month are long gone. Fundamentals like reducing debt, it would seem, are back in style.
Now, the average consumer certainly didn't have the opportunity to run up a few trillion in debt before they got cut off or their credit was dinged. But FICO and other credit-scoring algorithms do reward consumers who have a low credit utilization ratio, meaning that they responsibly use credit, but have a large amount of unused credit.
Under FICO's system, the ideal scenario is for 70 percent of available credit to be free. Living in a constant state of maxed-out credit balances is penalized in consumer credit, just as it was in the federal credit debacle.
In a crisis or pinch, borrowers with maxed-out bills are much more likely to default. And maxed-out bills are also a signal of poor financial management, waving a red flag that you live above your means, and might even be using credit cards to live off of (sort of like our government does).
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