Monthly Mortgage Payments Could Increase Rapidly if the U.S. Defaults on Its Debt. Here's Why

The possibility of a U.S. debt default has been making headlines in recent news, and for a good reason. The aftermath of default could have far-reaching effects on every aspect of the economy, including mortgage payments. Here's how a U.S. default may impact monthly mortgage payments and what we can do to prepare ourselves.

What is the debt ceiling?

The first debt limit was set by Congress in 1917. Similar in function to a credit limit for a credit card, the debt limit ensures that the federal government operates within its means and does not spend beyond its allotted resources.

The government has hit the debt ceiling, and if Congress doesn't raise it soon, the U.S. won't be able to borrow money and would default on all its obligations. If this happens, the country's economic stability would be put at risk.

How does a default affect mortgage rates?

Should the U.S. default, it would be unable to pay its creditors. When investors lose confidence in the U.S. government's ability to repay its debt, they demand higher yields to compensate for the risk. This, in turn, would result in a chain reaction of higher interest rates across the board -- including on mortgages, credit cards, and car loans.

The ultimate result? These financial products would all become more expensive for everyone. For those in the housing market, this could mean a sharp increase in borrowing costs and a decrease in sales activity.

According to a recent Zillow report, mortgage rates could increase significantly, possibly up to 8.4%. Such a rise in interest rates means that monthly payments on a typical $500,000 home would increase by 22% up to $3,800, compared to a monthly payment of $3,095 with a 6.3% interest rate.

How would a default affect the house market?

A significant increase like this would put homeowners under considerable financial stress, and some might not be able to pay their mortgage and be foreclosed on. Higher mortgage rates would lead to a drop in the overall demand for homes.

Higher mortgage rates will also reduce home appreciation values. However, according to Zillow forecasts, the impact on home values is expected to be modest. Home values would dip by 1% from current levels starting in August until February 2024 but are expected to end up 1% higher by the end of 2024 compared to current values.

Steps you can take

Nobody wants a U.S. default to happen, as the ripple effects can damage the economy, the housing market, and affect millions of people. Although we cannot control what happens, we can position ourselves better just in case such a scenario occurs.

If you're a home buyer, you might want to consider locking in a low rate now by getting pre-approved for a mortgage and shopping around for the best rates and terms. This can help you secure a lower monthly payment and reduce the risk of rates rising later.

If you're a homeowner, you could refinance your existing mortgage to a lower rate (which would be hard in today's rate conditions) and save money on interest or shorten the term to pay off the loan faster. You could also pay down your mortgage principal faster by making extra payments or switching to bi-weekly payments. This would also reduce the amount of interest you pay over the life of the loan.

A U.S. debt default is not a certain outcome, so it's essential to stay informed and not make any rash decisions regarding your mortgage payments and real estate investments. Homeownership is a long-term investment, whether the interest rates are high or low. The most important thing is to make decisions based on facts, not fear.