It would be hard to imagine life without mortgage and consumer credit.
Mortgages have extended home-ownership beyond the ranks of those on high incomes or with large amounts of capital. Credit has helped bring other major purchases, such as a new car or a kitchen, within the reach of most households. For the wider economy there are benefits too, since access to credit helps keep households going when incomes are under pressure.
Like most innovations, from the car to the computer, debt has also created problems. They have been all too clear in the wake of the financial crisis. From double-digit growth in car finance to student debt and ‘pay-day’ lending, consumer debt is a hot topic.
How worried should we be about levels of household debt?
The overall picture is less alarming than some of the headlines suggest. The bulk of household debt is not in the form of credit cards, overdrafts or pay day loans, but mortgages. Mortgages account for around 80% of the stock of debt. Since the financial crisis banks have become more wary and selective in lending and mortgage lending has been subdued. Since 2010 net mortgage lending has risen by an average of just 1.8% a year, compared with 10% a year growth in the decade before the financial crisis.
Unsecured credit, mainly credit card, car finance and overdrafts makes up the remaining 20% or so of total consumer debt. Growth here has been stronger, at 6.7% a year, although this is roughly half of the rate seen in the decade before the financial crisis. Car finance through personal credit plans has been the main driver of unsecured debt, with year-on-year increases of around 20% in the period 2014-16. Since then banks and regulators have tightened up on unsecured lending and growth in car finance has halved. Year-on-year growth in all unsecured lending, including cars and credit cards, fell to 8.5% in July, the slowest rate in almost three years.
Levels of household debt in the UK do not look extreme by international or by historical standards – though such comparisons are no guarantee of safety. The ratio of debt-to-income stands at 133% in the UK, down from 148% in 2007. While many countries, including the US and Germany, have lower debt levels; others, especially in the Anglosphere and Northern Europe, are more indebted. Household debt levels in Denmark, the Netherlands, Australia and Sweden are far higher than in the UK.
Measuring debt relative to incomes provides a partial picture of the ability of households to manage. To get a more rounded view we need to look at the asset side of consumers’ balance sheets and at debt servicing costs. On both fronts the news is fairly positive.
UK households have taken on more debt in recent years, but the value of their assets has risen much faster. Total UK household debt has risen by 19% since 2010 while the value of housing and financial assets, mainly shares, savings products and pensions, have increased by 44%. Meanwhile money is cheap and the average UK mortgage rate is less than half what it was ten years ago. Interest rates on personal loans have fallen too. However, borrowing through overdrafts and credit cards has become even more inadvisable, with interest rates on this type of debt higher than it was ten years ago.
The current state of household balance sheets has been shaped by monetary policy since the financial crisis. Quantitative Easing and low interest rates have collapsed the cost of money and pushed up the value of property, equities and bonds. The Bank of England set out to raise household wealth and reduce debt servicing costs, and it has succeeded.
Events could yet make manageable looking debt burdens unmanageable. A rapid rise in interest rates, and an unwinding of QE, would play havoc with consumers’ finances. This is why the Bank of England has emphasised that monetary tightening will proceed slowly and with great caution. It is possible to imagine shocks, such as soaring inflation, that might force the Bank to tighten policy more quickly. Or a demand shock, perhaps through a global slowdown or a chaotic Brexit, which would hit household finances and jobs.
These are risks but they are not, for now, the most likely outcome. For me the greater risk lies in who holds debt.
Most households with debt seem well placed to manage it. So, for instance, more than half of all unsecured debt, such as credit card borrowing, is held by households with above-average incomes.
There are also significant areas of vulnerability. The think tank the Institute of Fiscal Studies estimates that about 13% of UK households are under ‘immediate debt servicing pressure’ – defined as spending more than 25% of monthly after-tax income on servicing its debts or by being two or more months in arrears with a bill or credit agreement. The young and those on low incomes are most vulnerable. The IFS estimates that 25% of those in the bottom tenth of the income distribution are under debt-servicing pressure.
Younger and less skilled households are less likely to be working and do not have financial wealth to see them through difficult times. According to a National Audit Office report 22% of UK adults have less than £100 in savings.
A natural response to all of this might be to think that there is no level of household debt which is completely safe. But even if it were possible, trying to ‘bomb proof’ consumer finances by eliminating household debt wouldn’t work – consumers would be vulnerable to a host of other risks, from falling asset prices, unemployment and runaway inflation.
Like the free market or globalisation, society chooses to regulate and channel the provision of credit with the aim of maximising benefits and minimising risks. Policymakers must stay vigilant to the age old macroeconomic risks associated with consumer borrowing. Those risks are present but do not, for now, seem acute.
Debt problems today are concentrated in poorer households - and are part of a wider picture of low skills, low pay and less secure work. This is a set of challenges which extends way beyond the provision and regulation of consumer debt.
PS: Investors fled from emerging market (EM) assets last week amid global trade tensions and prospects of further US interest rate hikes. Over the summer, country specific issues such as structural weaknesses, poor policy or diplomatic row have led to full blown crises in Argentina, Venezuela and Turkey. This week’s moves seem to suggest a level of contagion with other EM currencies and assets also affected. EM equities officially entered a bear market, marking a 20 per cent decline from their peak in January. A number of EM currencies also descended to multiyear lows, with the Russian rouble and South African rand sliding to their lowest levels since 2016 and the Indian rupee hit a record low against the dollar.