2.2 When are debt levels too high?

Looking at these figures for personal debt might lead some to conclude that the levels are too high. This conclusion was reinforced by the growing rhetoric on the subject coming from the media, politicians and church leaders – particularly in the years up to the onset of the financial crisis in 2007. Yet determining whether debt levels are a problem requires consideration of a number of complex issues.

The first of these issues is to consider the level of debt, taking into account all assets and liabilities. A Bank of England report indicated that at the end of 2004 the net worth of all households in the UK – that is, the value of total assets minus total secured and unsecured debt – was about £5 trillion (Tudela and Young, 2005). This was a substantial rise from just over £2 trillion ten years earlier, with the majority being made up of wealth held in the form of housing, which stood at £3.2 trillion (Tudela and Young, 2005). The remainder consisted of other financial assets, for example, money held in savings accounts. A later survey by the Office for National Statistics (ONS) covering the period 2006 to 2008 found that private household net wealth in Great Britain in 2006/08 had grown further to £9 trillion (ONS, 2009). Therefore, at the level of the country as a whole, the value of total household assets is substantially greater than the total amount of household liabilities, a fact which might be interpreted as meaning that high and increasing levels of debt are affordable (Tudela and Young, 2005).

This leads us to the second issue: even if the value of household assets exceeds household liabilities, people may still have difficulties in making the repayments due on outstanding debts. There are different ways of defining when individuals and households are facing debt problems, and there is no universally agreed definition. ‘Over-indebtedness’, ‘problem debt’ and ‘financial difficulty’ can all be used as interchangeable terms for the same debt problems (DTI, 2005). ‘Over-indebtedness’ is a term used to describe debt that has become a heavy burden for the borrower. Citizens Advice defines ‘problem debt’ as ‘when an individual is unable to pay their current credit card repayments and other commitments without reducing other expenditure below normal minimum levels’ (Citizens Advice, 2003, p. 48). The definition of debt problems as having debt that is considered by the individual to be a heavy burden is especially interesting because it suggests that two individuals with the same financial circumstances may have different views as to whether their debt is a heavy burden or not! So a statistical measure often used in personal finance to measure ‘financial difficulty’ is whether debt repayments (excluding secured loans like mortgages) are 20 per cent or more of net income.

A 2004 UK Government publication showed that the proportion of people who saw debt as a ‘heavy’ burden stayed constant at around 10 per cent between 1995 and 2004 despite rising personal debt levels (DTI, 2004). Other studies published at that time concluded that the proportion of people’s income spent on loan repayments was broadly constant between 2000 and 2004 (Oxera, 2004), and that UK household debt as a percentage of household income was broadly the same as in the USA, Japan and Australia, only a little higher than in Germany, and lower than in the Netherlands and Denmark (Debelle, 2004).

Subsequently – and particularly after 2007 – evidence indicated that the number of people who at least had concerns about their debts was growing. In 2008/09, Citizens Advice found that debt was the largest category in terms of the volume of problems on which they advised clients, with advice being given to around 575,000 clients on 1.9 million debt problems during the year (Citizens Advice, 2009a). It also found that in 2008, 45 per cent of its owner-occupier clients had arrears on their mortgages or secured loans – this compared with 30 per cent of its clients in 2004 (Citizens Advice 2009b). Citizens Advice has also noted an association between debt problems and the number of credit cards held (Citizens Advice, 2003). In 2010 there were more credit and charge cards than people in the UK: 71.3 million credit and charge cards compared with around 60 million people (Credit Action, 2010b).

Evidence produced by the Bank of England also indicates that developments in the economy after 2007 resulted in more households finding their debts to be a burden. Between 2004 and 2008, the proportion of households that said they were having difficulties with their housing payments (including mortgage payments) doubled to 12 per cent (Hellebrandt and Young, 2008). By 2008, 33 per cent of households surveyed said that their unsecured debt was ‘somewhat of a burden’, while 14 per cent stated that it was a ‘heavy burden’ – both proportions being markedly higher than in the early and mid 2000s (Hellebrandt and Young, 2008). Such pressures, coupled with the onset of economic recession after 2007, were reflected in the growth of arrears on debts and a marked increase in the number of homes being repossessed by mortgage lenders in the late 2000s. In 2009, 47,700 properties were repossessed compared with 8200 in 2004 – although the number of new repossessions subsequently fell slightly in the first half of 2010 (Communities and Local Government, 2010).

This evidence leads to a third issue to consider when determining whether debt levels are a problem: how debt is distributed between different households, and whether debt is causing problems for particular types of households. Certainly, while liabilities are more than matched by assets across the UK as a whole, debt is more likely to be a major problem for certain categories of individuals and households. For example, those on low incomes and those in their twenties and thirties are more likely to have debt problems (DTI, 2005). A 2007 survey commented that around 50 per cent of those describing debt as a ‘serious problem’ were from a low-income group (Social Justice Policy Group, 2007).

Table 1 demonstrates the relationship between debt problems and family type. The table shows that family type single, not retired, with children are much more likely to be both in arrears and to have higher heavy burden indicators than all other family types (BIS, 2010).

The link between income levels and debt problems was identified again in a study by the Institute for Public Policy Research, which found that ‘not all low-income families use consumer credit or get into debt, but poverty and job insecurity increase vulnerability to debt problems’ (Ben-Galim and Lanning, 2010). The study goes on to note that ‘job insecurity and fluctuations in income and expenditure can expose poorer households to debt problems’ (Ben-Galim and Lanning, 2010).

Moreover, there is a link between low-income households and financial exclusion, including having less access to mainstream banking and loan facilities. This, in turn, means that low-income households turn to alternative sources of credit. Bridges and Disney (2004) found that the use of credit for catalogue and mail-order purchases was very common among low-income families. Since these alternative sources of credit are typically more expensive than mainstream credit – because the interest rate charged is higher – such financial exclusion increases the probability that debts become a burden and arrears are built up.

Debt problems also relate to family type. Families with children are more likely to be in arrears than households without children and, for families with children, lone parents are much more likely to be in arrears and to have two or more debt commitments (DTI, 2004). In addition, home ownership appears to play a role, with a study of debt among low-income families in the UK finding that tenants are much more likely to be in debt than homeowners (Bridges and Disney, 2004).

A further recent development has been the sharp increase in the number of women in the UK experiencing debt problems. In 2009, women accounted for 40 per cent of all bankruptcies, with the number having increased from 6042 in 2000 to 29,680 in 2009 (Independent, 2010).

Therefore, despite the fact that the data on debt across the whole of the UK show that the value of household assets is much greater than liabilities, a significant minority of households and individuals have debt problems. This minority appears to have been growing since the mid 2000s. Households with debt problems are concentrated in low-income groups, especially lone-parent households, many of whom face great financial difficulties (Brown et al., 2005; Citizens Advice, 2003; Kempson et al., 2004). In 2008, Citizens Advice found that the average net monthly income of their debt clients was less than two-thirds of the average monthly household income in the UK (Citizens Advice, 2009c). Nevertheless, even those who own their own home but still have a substantial mortgage may have cause to be concerned about debt. A rise in mortgage rates, a crash in the housing market or, as might be expected, the introduction of substantial student fees in England, could cause severe financial hardship. The repercussions of a large number of households suffering financial hardship would, in turn, have a significant and detrimental impact on the whole economy.