Fresh concerns about household debt levels have been raised this week by the Resolution Foundation, a think tank that focusses on the UK’s standards of living. Their research suggests that an estimated 600,000 people currently need to use over half their net income to repay debts. Should interest rates begin to rise to around 3%, that number is expected to be over a million by the year 2018. Should the rates hit 5%, then that alarming estimate increases to some two million households facing enormous repayment commitments that threaten their financial stability.
The biggest area of UK household debt comes from mortgages, many of which pre-date the current financial situation. The problem is that even small changes in household income, coupled with a rise in the cost of borrowing, can rapidly cause much larger problems than may seem immediately apparent. With the job market still precarious and incomes largely frozen even though inflation is rising, household margins are being squeezed more and more. To put things in perspective, just before the global financial meltdown in 2007, the number of UK households in what the Foundation calls “debt peril” stood at around 870,000.
Debt peril is defined as being a situation where over half of a household’s disposable income – essentially what you take home after tax and national insurance – is needed to make payments on debts.
The figures paint a gloomy picture, taking in all forms of household debt, including credit cards and other bank loans, and much now depends on how the Bank of England acts in the next few months. Since the beginning of 2009, the Bank has kept a tight hold on interest rates, keeping them at a record low of 0.5%. Their policy is that it will not increase those interest rates until the UK rate of unemployment has fallen back below 7%.
A fall in this rate to 7.4% in the three months leading up to October this year is what has prompted concerns, as this rate is the lowest recorded since early in 2009. A number of economists, mindful of the Bank’s forward guidance policy, have been prompted therefore to say that they believe a rise in interest rates is likely to be announced in the New Year.
Just how bad does it look for UK households? Well according to recent estimates the average level of household debt in the UK is around £54,000 if you include mortgages. Compared to ten years ago, this is nearly twice what people were having to deal with in the years leading up to the current financial crisis, with households even more squeezed by the rising cost of living before they even get to the issue of servicing their debts.
If the Bank of England stands firm on its stated threshold for action, then things will remain difficult, but at least they won’t be more difficult. If interest rates do begin to rise though, this will make for a very unhappy New Year, and risk the precarious recovery that the UK is beginning to experience.