When a major credit agency like Moody’s Ratings downgrades the U.S. credit outlook, it can have real consequences for everyday Americans.
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While the downgrade doesn’t mean the U.S. has defaulted, it signals concerns about long-term debt and political gridlock.
Here’s what Moody’s downgrade of the U.S. credit rating means for the middle class.
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What Is a Credit Downgrade?
A credit downgrade is a signal that a country may be a riskier bet for lenders. In this case, it means that Moody’s Ratings (Moody’s) has downgraded the U.S. government to Aa1 from Aaa, and changed the outlook to stable from negative.
Moody’s downgraded the U.S. credit outlook due to growing concerns about the country’s long-term debt and budget challenges. The agency warned that without major changes to taxes and spending, rising interest payments and entitlement costs could severely limit the government’s financial flexibility.
While the U.S. maintains its top credit rating with Moody’s for now, other agencies like Fitch and Standard & Poor’s have already issued downgrades. These changes reflect concerns about the government’s ability to manage its finances, not an immediate crisis.
“While we recognize the U.S.’ significant economic and financial strengths, we believe these no longer fully counterbalance the decline in fiscal metrics,” Moody regulators said.
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How Does This Affect Interest Rates?
A downgrade can raise borrowing costs for the federal government. In turn, this often leads to higher interest rates for consumers on everything from mortgages to credit cards.
“This is because if the U.S. is seen as a risky borrower, investors may demand higher interest rates in exchange for taking on what they see as greater risk in lending to the U.S.,” said David Beahm, president & CEO of Blanchard and Company.
Beahm explained, “This could lead to higher U.S. Treasury bond yields, which would then affect (and likely increase) interest rates on auto loans, credit cards and mortgages. With credit card defaults at their highest levels in 14 years, an increase in borrowing costs would be a heavy burden for many Americans.”
Investments and Retirement Accounts
Middle-class Americans with 401(k)s, IRAs or brokerage accounts may experience increased market volatility. A credit downgrade can significantly shake investor confidence, particularly in government-backed securities such as Treasury bonds.
While long-term investors shouldn’t panic, those nearing retirement may want to reassess their asset allocation to ensure they’re protected against bond market fluctuations or rising inflation.
“Consider diversifying your investments so you’re not over-exposed to a single asset class or currency,” Beahm said. “If you spread your investments across real estate, stocks, bonds and physical commodities like gold, you can reduce the risk of your investments being tanked by poor performance in a single asset class.”
Raise Taxes or Cut Spending
At the heart of Moody’s decision to downgrade the U.S. credit rating was a tension between increased government spending in mandatory programs, mushrooming federal debt, and less revenue due to federal tax cuts.
“Over more than a decade, U.S. federal debt has risen sharply due to continuous fiscal deficits,” Moody’s regulators said. “During that time, federal spending has increased while tax cuts have reduced government revenues. As deficits and debt have grown, and interest rates have risen, interest payments on government debt have increased markedly.”
If the government struggles to manage its debt, there may be pressure to raise taxes or cut spending on Medicare and Social Security.
“As interest rates rise, the government may have to allocate more portions of its budget to interest payments, which would cause funds to be diverted from other essential programs,” said Aaron Razon, a personal finance expert at Couponsnake.
Razon added, “This could also lead to a ripple effect on the overall economy, ultimately impacting the financial stability of American households.”
The Bottom Line
A U.S. credit downgrade doesn’t mean disaster, but experts said it’s a warning. For the middle class, it signals a higher-cost environment, more market uncertainty and possible shifts in public policy.
“One long-term consequence the average household should understand is that a prolonged period of higher borrowing costs and the potential economic uncertainties that would likely follow could impact their financial stability and wealth accumulation,” Razon said.
He added, “In light of the rating downgrade, two major financial moves that middle-class Americans should consider making now are considering fixed-rate loans and keeping an eye on interest rate changes to know when and how to adjust their financial plans accordingly.”
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This article originally appeared on GOBankingRates.com: What Moody’s US Credit Rating Downgrade Means for the Middle Class
