What the Debt Ceiling Debate Means for Your Money

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Your five-minute guide to the debt ceiling debate. 

The United States officially hit its debt ceiling on Thursday, Jan. 19, according to a letter from Treasury Secretary Janet Yellen. That means it has reached the $31.4 trillion limit agreed in December 2021 and will now have to rely on “extraordinary measures” to meet its obligations.

Yellen is asking lawmakers to increase the amount the U.S. can borrow. “Failure to meet the government’s obligations would cause irreparable harm to the U.S. economy, the livelihoods of all Americans, and global financial stability,” she warned.

But what is a debt ceiling? What happens now? And will any of it have an impact on your finances?

What is the debt ceiling?

The debt ceiling or debt limit is the amount of money the U.S. government is allowed to borrow to cover its costs. It’s a bit like the limit on your credit card. It is set by Congress and was first put in place in 1917. That money gets used for various things, including Social Security payments and federal workers’ salaries.

The government spends more than it brings in each year and the amount the country owes has been creeping up for some time. According to Fiscal Data, created by the U.S. Treasury, the federal debt has increased from $408 billion in 1922 to $30.93 trillion in 2022. Increasing the debt limit doesn’t authorize additional spending. Rather, it allows the government to borrow to pay for spending that’s already been agreed upon.

The country has reached the limit on what it can borrow and the clock is ticking. But we haven’t reached the edge of the cliff yet. Yellen’s letter marked the start of a debate that could continue for several months. The Treasury has some tricks up its sleeve, such as stopping certain investments and moving money around to keep things running for now. The New York Times estimates the crunch point will come around June, which gives lawmakers in Washington a few months to find a solution.

A change to the debt limit needs to be passed by both the House and the Senate. Without getting into the politics, raising the debt limit no longer happens as a matter of course. Some politicians want to put conditions, such as spending cuts, on any increase. Others feel the consequences of not raising the ceiling are so serious that it shouldn’t be up for negotiation. There’s never been a situation where the government can’t meet its obligations because the limit has always been increased. All the same, you can expect the topic to dominate the headlines for a while yet.

How could the debt ceiling impact your money?

It is extremely unlikely the government will fail to raise the debt ceiling, even if the debate continues right up until the last minute. Nobody knows exactly what will happen, but part of the reason it’s such an improbable scenario is that the consequences would be dire.

Here are some of the ways a failure to increase the debt ceiling could impact your finances.

1. Delays to paychecks and Social Security payments

If the Treasury runs out of ways to move money around and the debt ceiling has not been increased, it would have to pause some of its obligations. According to the Committee for a Responsible Federal Budget, these include Social Security payments, salaries for federal employees, military salaries, and veterans benefits, amongst other things.

2. The U.S. might default on its debt

If the U.S. defaults on its debt, the Washington Post reported that it could have a significant impact on the job market and Americans’ abilities to build wealth. Quoting Moody’s Analytics, it said a default could “cost the U.S. economy up to 6 million jobs, wipe out as much as $15 trillion in household wealth, and send the unemployment rate surging to roughly 9 percent from around 5 percent.”

Moreover, there are consequences to even the possibility that it might default. For example, in 2011, when negotiations to raise the debt ceiling almost reached a standoff, Standard & Poor’s downgraded the U.S. credit rating for the first time ever. A lack of confidence in America’s ability to pay its bills could result in higher interest rates for borrowers, which would impact people’s mortgage loans, car loans, and credit cards.

Finally, it could have a negative impact on stock market investments, albeit a short term one. Reuters reports Goldman Sachs analysis showing the S&P 500 fell 15% during the 2011 showdown. It warns an actual default would “send shockwaves through global financial markets.”

How you can prepare

If you’re worried about even the slight possibility that Washington might fail to raise the debt limit, there are a couple of ways you can prepare. One is to put some extra cash into your emergency fund in case payments get delayed or the economic instability leads to job losses. The usual recommendation is to have three to six months’ worth of living expenses in a savings account to tide you over. But the debt ceiling debate combined with warnings of a potential recession mean you might want to have more in the bank.

If you are planning to buy a house or take on a fixed-rate loan in the near future, know that there’s a small chance rates will increase. That said, don’t rush into a decision. Interest rates have already risen dramatically in recent months and we don’t know what 2023 will bring. On the other hand, if you carry high-interest credit card debt, the more debt you can pay down, the better. It isn’t easy, but if we enter difficult economic waters, that debt could weigh you down and make it harder to stay afloat.

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The Ascent does not cover all offers on the market. Editorial content from The Ascent is separate from The Motley Fool editorial content and is created by a different analyst team.Emma Newbery has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Goldman Sachs Group. The Motley Fool has a disclosure policy.

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