The strong growth in secured and unsecured household debt in recent years will put extra pressure on household finances.
This article, by the CML's head of research, Bob Pannell, looks at what we know about current levels of debt, the ability of households to meet their commitments and what tips them over the edge, so that they can no longer keep up with all their payments. It concludes:
Despite increasing levels of personal indebtedness over the past decade or so, there had been little evidence suggesting the fragility of household finances until last year. Substantially higher food and fuel costs in the early part of 2008 appear to have been an important initial trigger behind pressure on households.
While many more households than a few years ago are now struggling, the position appears to have stabilised over recent months, as retail prices have eased and substantial cuts in interest rates since late 2008 have lowered the costs of servicing mortgages for many households.
As at February 2009, about a quarter of British households – or roughly 6 million – reported that they were struggling to keep up with their bills or were actually falling behind. Of these, one million were falling behind on many commitments and a similar number falling behind on at least some of them.
Generally, home-owners, whether they have a mortgage or not, appear much less susceptible to problems than those who rent. There are many reasons for this, but in part it reflects the fact that problems with unsecured debt are much more commonplace and that home-owners have a wider range of ways of coping.
Where borrowers have mortgage problems, they are also likely to be behind with unsecured debt commitments.
Unexpected spending, on things like replacing major household items or car repairs, recently seems to have been the most important single source of financial difficulties for households generally, including mortgage borrowers.
While loss of income is a significant factor in payment problems, it has appeared less prominent in recent months than long-standing results from the Survey of English Housing would suggest. For the time being at least, payment difficulties are just as closely associated with sickness as with redundancy.
Household changes loom less large and, where they do occur, seem primarily associated with the arrival of a new child or some other new carer role, rather than relationship breakdown.
Clearly, a myriad of factors can combine to affect the ability of individual households to keep their heads above water. Given the unprecedented nature of the economic times we are living through, the factors shaping this have the potential to change rapidly going forwards and we need to monitor market developments closely.
Household debt
The broad picture is that households have become progressively more indebted over the past decade or so – and considerably more so than ever before. Until recently, however, this did not appear to be too much of a problem, because the number of households struggling with financial commitments had stayed relatively low.
As recently as 2007, the Bank of England concluded that “there have been few signs yet of a substantial increase in household financial distress at the aggregate level.”
Research by the Financial Services Authority largely reiterated the view that very few households were falling behind with their commitments, but also highlighted that payment shock – where the cost of servicing a loan rises – or a deterioration in the wider economy could result in many more consumers falling into difficulty.
The vulnerability of household finances has become much more apparent over the past year. As Chart One shows, there has been a large increase in the proportion of households experiencing difficulty with their debts and other commitments.
Although most households participating in NMG research for the Bank of England said they could keep up with bills and commitments, 10% indicated that it was constant struggle and 3% said that they were falling behind. Some households were having difficulty because of unexpected increases in household bills. Given the timing of the NMG fieldwork, this fits in well with our understanding that higher fuel and food costs in the first part of 2008 had materially shrunk the amount of income available for discretionary spending.
YouGov research corroborates these findings generally but also suggest that the position has stabilised since last summer, presumably because of cuts in official interest rates.
According to YouGov results for February this year, 26% of British households – or roughly six million – said keeping up with bills a constant struggle or they had actually fallen behind with their commitments. Of these, one million are falling behind on many commitments and a similar number again falling behind on at least some commitments.
Profile of debt problems
In recent years, home-owners, whether they have a mortgage or not, have been less susceptible to problems than those who rent. Partly, this is because having housing equity gives home-owners more options for coping (including the use of draw-down facilities, refinancing, further secured borrowing and an ability to trade down or sell property outright).
But it also reflects the fact that most problems are linked to unsecured debt. This is readily illustrated by the fact that there were 106,544 individual insolvencies in England and Wales last year, compared with 40,000 mortgage possessions across the whole of the UK.
Generally, mortgage borrowers have few problems with unsecured debt. But of the relatively small numbers who are behind with their mortgage payments, many are also likely to have unsecured debts and to be experiencing difficulties in meeting these commitments, too. This fits in with our anecdotal understanding that many of those households with mortgage problems have complex financial arrangements and multiple debts.
Respondents to the Survey of English Housing are allowed to give more than one reason why they have fallen into arrears, and this is why the figures in Chart Two add up to more than 100%. As can be seen, the survey has for many years shown that loss of income is the main factor behind mortgage arrears.
However, an informal CML poll of some large lenders earlier this year suggested that loss of income had contributed to problems in less than half of current arrears cases. This is not necessarily incompatible with the SEH findings, which are less up-to-date, and it is certainly possible that the credit crunch has altered the normal parameters.
The YouGov survey asks households what has happened to them in the preceding 12 months. When viewed alongside how well households are keeping up with their bills, this provides helpful insights into why people may be struggling with their finances. The table needs to be read vertically. So, for example, among all respondents keeping up with their bills and commitments without difficulty, 21% had experienced a loss of income this year
What we see is a clear correlation between disruptive experiences and the extent to which households struggle with their bills and commitments. Put simply, the more people are struggling with their finances, the more likely they are to have experienced one or more negative events in the previous year.
It is also true that, among households struggling financially, mortgage borrowers are more likely to have suffered disruptive events in the past year, and for borrowers falling behind with their mortgage this is even more likely. What this appears to show is that because they are better able to cope with adverse shocks, mortgage borrowers have to endure more setbacks before they struggle.
Looking at the data, higher spending in all cases is more disruptive that loss of income. Typically, this relates to replacing major household items and car or property repairs.
While loss of income continues to be an important reason for falling behind with payments, this was just as closely associated with sickness as with redundancy.
Household changes have less impact than the above factors and, where they do occur, they seem to be primarily associated with the arrival of a new child or some other new role as a carer, rather than relationship breakdown.
Generally, the loss of credit facilities seems less prominent, although interestingly it does register strongly among the relatively small numbers of struggling mortgage borrowers. That may simply reflect short-lived, and ultimately unsuccessful, efforts by such households to juggle their finances by robbing Peter to pay Paul.
While we should avoid reading too much into results covering just a few quarters, it is clear that a variety of factors intertwine to affect the ability (and willingness) of households to keep up with their bills and commitments. As far as mortgage debt is concerned, significant house price falls, the very sharp easing of interest rates in recent months and the prospect of materially higher unemployment make for a very dynamic picture, and one that we shall continue to monitor closely.
