UK household debt has almost equalled annual GDP, and consumers are already tightening their belts. What will this mean for the UK economy?
What’s the damage?
Substantial. Bank of England figures show household debt in the UK is standing at nearly £1.175trn, almost as much as our entire annual gross domestic product (GDP). Mortgage lending accounts for about 84% of that, the rest being consumer loans, such as credit cards and overdrafts. Apart from the size of these debts, what’s particularly notable is how quickly they’ve risen. Borrowings have almost doubled since 2000 on the back of rocketing house prices and the biggest consumer-spending boom in the UK’s history.
Is that much debt a bad thing?
Not necessarily. While some people think of debt as intrinsically bad, it’s as crucial to the modern world as the development of currencies were to the first trading economies. Our complex systems of lending allow money to be channelled to whoever can make use of it, letting people invest in their futures and lenders earn a return on their capital.
Of course, a good chunk of the money owed has been splurged on the high street, but it’s the borrowers’ prerogative to choose how to spend their loans; the main concern from an economic point of view is whether they can afford to repay them afterwards.
So what’s the problem?
The structure of this debt mountain doesn’t look very safe. Optimists point out that the £980bn owed on mortgages isn’t that much of an issue as it’s outstripped by the estimated £3.4trn value of the UK’s private housing stock – although if you share MoneyWeek’s view that house prices are grotesquely overinflated, that argument becomes less reassuring. But it’s hard to find any positives about the amount of unsecured debt.
Recent research by a debt-advice firm found that nearly two million people owe more than £10,000 on credit cards, overdrafts and unsecured loans. That includes one in 20 people aged between 18 and 24, which is seen as especially worrying because lower average incomes and assets in that age group means there is a greater risk that they won’t be able to service such large borrowings.
Are people increasingly defaulting on debt repayments?
There’s no crisis at present, but there are some disturbing trends. Repossessions by banks rose 70% to 10,250 between 2004 and 2005, although this is still well below the 75,540 recorded in 1991 during the depths of the recession. Personal insolvencies are at record levels: there were 13,500 personal bankruptcies in England and Wales during the fourth quarter of 2005, a 38% increase on a year ago. Individual voluntary arrangements – in which people come to a repayment agreement with their creditors – rose 117% to almost 7,000 in the same period. And many people are highly exposed to interest rates, with a Financial Services Authority survey finding that an extra 7% of consumers might struggle with their mortgages if rates rose by half a point.
Are people worried yet?
On the whole, no. Surveys consistently report that most borrowers see no problems with the amounts they owe. In a recent Experian poll, 75% say they were “comfortable” with their level of debt and 85% said they were confident that they would be able to meet their obligations.
But the number of people seeking advice on debt problems is increasing. Charity helpline National Debtline reported that January was the busiest month it had experienced since it was set up in 1987. As far as that troublesome 18-24 age group goes, the Consumer Credit Counselling Service reported last year that the proportion of its clients under 25 had doubled in three years and the average amount they owned had increased by a quarter.
Do they plan to borrow more?
Most say not. In the Experian poll, 32% were expecting to reduce their debt, compared with 11% who predicted an increase. An analysis from Longview Economics found that consumers’ intention to save is at its highest level since 1997.
Of course, this is just what most people say they plan to do, and there can be many a slip twixt cup and lip. But there are a couple of indications that a shift has begun. The household saving ratio climbed from 4.3% to 5% between 2004 and 2005, and the annualised rate of growth in consumer lending slowed to 8.7% in February, its lowest level since July 1994. Against that, mortgage lending growth is rising again as a result of the recent bounce in house prices.
What will a borrowing slowdown mean?
More gloomy news for retailers. The high-street boom was largely financed by the increase in debt, both on unsecured loans and equity withdrawal from houses that had shot up in value. As consumers’ focus switches from borrowing to paying off their debts and saving, there will be less money to spend in the shops and the current retail slump may last for some time.
A struggling retail sector is also bad for the UK’s overall economic growth, as almost 70% of GDP is due to consumption. This doesn’t bode well for Gordon Brown’s chances of meeting his budget forecasts.
What about the banks?
Eager borrowers have meant a bonanza for banks, helping many to make record profits last year. But overstretched spenders could mean trouble ahead. The Bank of England estimates that banks wrote off £5.23bn in unsecured loans last year, a 26% increase on 2004. Barclays recently announced a 44% increase in bad-debt provisions as a result of more borrowers missing credit-card payments.
By Chris Sholto Heaton