Britain in the Red: Why we need action to help over-indebted households

Executive summary

It is now over eight years since the onset of the global financial crisis and the Great Recession. Private indebtedness is widely understood as a major underlying cause of the crisis, as high-risk loans and sub-prime mortgages fatally undermined the stability of major financial institutions. While there has been a good deal of emphasis since 2008 on the household elements of private debt, this has tended to be dominated by mortgage debt. The ‘Britain in the Red’ project was set up to look in more detail at what has happened to households’ use of consumer credit.

Households borrow either to spread their spending over a longer period, or when their everyday costs cannot be covered by their income. With households experiencing an unprecedented decline in real earnings, the obvious concern is that more households are finding themselves unable to cover their living costs without taking on debt. In the wake of the very large build-up of debts on consumer credit over the decade from 1997 to 2007, they are also find existing repayment costs significantly harder to manage.

While there has been some improvement in overall levels of indebtedness since debt peaked ahead of the crisis, unsecured borrowing began to rise from 2014 and is forecast by the OBR to return to its peak in five years’ time.

Total unsecured debt for UK households (which includes credit cards, payday loans etc and student loans. but not mortgages) rose by £48bn between 2012 and 2015 to reach £353bn. Unsecured debt previously peaked at £364bn in 2008 and fell in the recession. The increase since 2012 increase is in part due to the major extension of student loans.

Consumer credit (i.e. household borrowing excluding both student loans and mortgages) peaked in 2008 at £230bn; it fell back to £184bn in 2012, but had risen again to £212 by the end of 2015. Bank of England figures now show consumer credit growing at an annual rate of 10 per cent, the highest for over ten years.

This report shows that many conventional measures may understate the scale of these debts and the burdens associated with repayment, due to complexities in the National Accounts measures of household debt, the increased role of student loans and the treatment of loan rescheduling and write-offs. In addition, in terms of households’ ability to meet the cost of interest payments, conventional measures do not take into account recent increases in the costs of living. The report therefore suggests alternative measures of indebtedness. In particular a new measure of debt servicing is derived, showing interest payments as a share of a household sector ‘surplus’ – that is, the amount that households have left to meet the cost of debt payments once living costs have been taken into account. This suggests the burden of 5 indebtedness has risen in recent years in contrast to falls on conventional measure. On this basis, interest payments on unsecured borrowing are at an all-time high, and are high relative to other countries.

This high burden comes as the cumulative effect of previous indebtedness is exacerbated by the fragility of household finances since the crisis. While spending has risen more slowly than before the crisis, it has come alongside greatly reduced income growth in the wake of the earnings crisis.

While these figures are indicative of pressures on the economy as a whole, the most significant impact is distributional. The discussion is based on two measures.

Financial vulnerability

Financially vulnerable households have debts that are worth 60 per cent of their income. Since the preliminary report was published in September 2015 there has been an improvement in measures of vulnerability, as wage growth picked up in 2015. However measures remain elevated and the acceleration in wage growth already appears short-lived.

Average debt to income ratios, by income quintile, 2013–2015

Moreover the lowest income decile is considerably more vulnerable. In 2015 the unsecured debt to income ratio of lowest income households was 22 per cent, seven times as high as the ratio of those in the highest income group (para 3.26).

Over-indebtedness

Households in problem debt have to spend more than 25 per cent of their monthly income paying the interest on their debts (credit cards, loans, overdrafts, arrears).

Correspondingly there has also been some improvement in debt servicing measures and hence over-indebtedness into 2015, though measures are still severely elevated relative to 2012.

Average debt servicing to income ratios, by income quintile 2012–2015

Overall, 11 per cent of households holding any form of unsecured debt are estimated as over-indebted in 2015, more than double compared to the 5 per cent in 2012. Of the over-indebted households, half are extremely over-indebted and so paying out more than 40 per cent of their income to their unsecured creditors (para 3.40).

In total, 3.2 million households or 7.6 million people are over-indebted, an increase of 700,000 or 28 per cent since 2012. On this basis nearly one in eight of all UK households are currently over-indebted (para 3.44). Likewise, 1.6 million households are in ‘extreme debt’.

For households earnings £30,000 or less, 16 per cent were over indebted in 2015 the same as in 2014 and up from 9 per cent in 2012 (para 3.41).

However the share of extremely over-indebted low income households rose to 9 per cent in 2015, up from 8 per cent in 2014 and three times as many as in 2012. Overall, 1.2 million low income households are estimated to be in extreme problem debt.

Even more worrying is that extreme over-indebtedness is growing particularly quickly in low income households that are in employment (excluding selfemployment). In 2015, 9 per cent of low income households in employment were extremely over-indebted, up from 5 per cent in 2014.

The final section includes conclusions and recommendations.

Following the discussion of the measurement of household indebtedness, proposals are made for future monitoring of the household debt burden and also actions to facilitate reducing this burden.

• Improve the monitoring of the household debt burden.
• Establish a target to reduce the household debt burden.
• Implement effective measures to achieve the target.

Most obviously actions are needed to strengthen household incomes through higher wages. These should follow from actions to strengthen the economy, including increased infrastructure spending and the development and implementation of an industry plan. Specifically on debt, actions should build on existing re-packaging and refinancing initiatives to reduce both the stock of household debt and the interest paid on consumer credit liabilities. We argue that if the government took a more active role more progress could be made in both reducing the pressures on households and also in strengthening banks’ revenues. The government should also review the current debt advice and insolvency system, with the aim of a system that is cheap to access and provides sufficient protections to enable a fresh start.

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