Household debt is ticking time bomb

Nia Williams

August 20, 2014

The research, by independent research company Verum Financial Research, shows that households have been unable to take advantage of record low interest rates since 2009 to pay off high and still rising levels of accumulated debt.

It points out that the household sector’s failure to reduce debt is a ticking time bomb for the UK economy.

Although total aggregate household assets exceed household liabilities, there is a mismatch between the households that own most of the assets and those that owe most of the debt.

Households with the highest asset wealth are those where the head of household is aged 55-64 while those with the highest level of debt are where the head of household is aged 35-44.

Verum’s analysis of official consumer credit data shows that if interest rates rise to 3% it would wipe nearly £30 billion from household discretionary spending, due to higher debt interest payments. This would be enough to tip the UK economy back into recession.

Official data shows that consumer insolvencies were much higher at the end of 2013 at 122,000 with interest rates at just 0.5% compared with the previous ‘interest-rate recession’ of 1990/91, when interest rates reached 14.6% but consumer insolvencies reached just 36,800. Since 1990, the amount of credit owed by UK households more than quadrupled from £347 billion to £1,437 billion in 2013.

Significantly higher debt levels, which have grown from 90% of household disposable income in 1990 to 130% in 2013, mean that households are much more vulnerable to marginal increases in interest rates.

Professor James Fitchett, of Leicester University School of Management, says in a foreword to Verum’s report: “The main problem facing the UK economy is therefore now a problem concerning consumer spending and debt.

“As these data show in considerable detail, the prospect of even slightly higher marginal lending rates could have a catastrophic effect on the economy.”

Households’ inability to pay off accumulated debt has been compounded by the increased cost of living combined with a real terms drop in income. Since 2009, non-discretionary costs have remained stubbornly high at just below the ‘recession risk’ level of 55%.

The report states that a small increase in interest rates and debt servicing costs will quickly take non-discretionary spending above the 55% recession level.

Robert Macnab, Verum’s director of research, commented: “With household finances under such pressure, any rise in the abnormally low interest rates will have a negative impact on consumer discretionary spending and economic recovery.

“Our research has identified an important threshold when 12% of household disposable income goes to servicing debt interest payments.

“At this level households cut back significantly on discretionary and often credit-sensitive purchases (such as vehicles, holidays, durable goods and furniture), a scenario which would bring the recovery to a grinding halt.

“To reach this 12% threshold, base rates would only need to rise to 3%. If mortgage rates followed suit, repossessions and consumer insolvencies would rise sharply and reach economically and socially damaging levels.”

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