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Dealing with Debt
The prospect of rising interest rates and the UK’s household debt problem
Katie Blacklock & Matthew Whittaker
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#ukdebt
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Despite economic improvement, UK has potentially large debt overhang that requires careful dismantling
• Household debt increased significantly in recent decades, particularly in the pre-crisis years
• Driven by rising demand (in part due to rapid house price growth) and easier supply (with a loosening of credit criteria)
• Entered the downturn with sizeable household debt burden which hasn’t been adequately dealt with
• A changing environment – and rate rises in particular – raises new challenges
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#ukdebt
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UK household borrowing increased rapidly pre-crisis, driven primarily by secured lending
Debt as a share of
household incomes rose sharply from
2002, reaching a peak of
170% immediately
prior to the financial crisis
Increase was
primarily driven by a
growth in secured lending
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Source: OECD & OBR
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Households have since gone through some de-leveraging, but the UK still stands out
Debt to income ratio has fallen in the UK, but
remains higher than in most
other countries at 140%
De-leveraging in the US has
taken the ratio below 120%
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Source: OECD & OBR
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And the OBR thinks that the period of de-leveraging has come to an end
Source: OECD & OBR
Projections from March
2014 suggest the UK debt to
income ratio will head back to its pre-crisis
peak by the start of 2019
As before, this is expected to
be driven by secured lending
associated with house
price increases
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Despite the UK’s exposure, the household debt fall-out post-crash has been relatively muted
Numbers of households in
arrears on their mortgage
and having their home taken into
possession rose sharply
after the financial crisis,
but did not reach the
levels anticipated
and have since fallen
Source: CML
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• The relatively small house price correction – But there are regional differences
• The surprising resilience of employment – But real wages have tumbled
• Loose monetary policy – But interest rates are set to rise again
• Lender forbearance & government support – Likely to unwind as house prices and interest rates rise
Thanks to four key factors, all of which are subject to some uncertainty
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But, despite historic low base rate, mortgage difficulties remain elevated
Given depth of recent
downturn and falls in
earnings and incomes,
falling borrowing costs have
provided only partial relief
for many mortgagors
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Source: Bank of England, NMG Survey 2013
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And can’t necessarily rely on strong rebound in earnings during economic recovery
Typical earnings were
flat in real terms even before the
start of the downturn. They have
since fallen by around £2,000
a year, taking them back to a level last seen at the turn of
the century
And recovery in pay is set to
be slow at best
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Source: Modelling based on OBR, Economic and Fiscal Outlook
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Even under gradual rate rises and falling lender spreads, exposure to debt is set to increase
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If the base rate rises in line
with current expectations and lenders continue to
narrow their spreads, the
proportion of mortgagor households
spending more than one-third of their after-
tax income on repayments is set to double
by 2018 Source: Modelling based on DWP, Family Resources Survey
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Afford
abili
tyHighly geared households in 2014
(base rate at 0.5%)
1,130,000
13%
2,330,000
27%
Re-finan
cing
Very low equity households in
2014
Afford
abili
tyHighly geared households in 2014
(base rate at 0.5%)
Highly geared households in 2018
(base rate at 2.9%)
760,000
9%
2,760,000
33%
At ris
k Highly geared in 2018 and potential
mortgage prisoners in 2014
Re-finan
cing
Very low equity households in
2014
Other non-standard circumstances
in 2014
770,000
9%At ris
k Highly geared in 2018 and potential
mortgage prisoners in 2014
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Potential ‘mortgage prisoners’ will find their options for re-financing limited
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Re-mortgaging options today
are likely to be limited for
those with less than 5% equity
in their home and for some other groups
We add those
with interest only
mortgages and the self-employed to
create an imperfect
proxy Source: Modelling based on DWP, Family Resources Survey
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Afford
abili
tyHighly geared households in 2014
(base rate at 0.5%)
1,130,000
13%
2,330,000
27%
Re-finan
cing
Very low equity households in
2014
Afford
abili
tyHighly geared households in 2014
(base rate at 0.5%)
Highly geared households in 2018
(base rate at 2.9%)
760,000
9%
2,760,000
33%
At ris
k Highly geared in 2018 and potential
mortgage prisoners in 2014
Re-finan
cing
Very low equity households in
2014
Other non-standard circumstances
in 2014
770,000
9%At ris
k Highly geared in 2018 and potential
mortgage prisoners in 2014
#ukdebt
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With those facing the double exposure appearing particularly vulnerable to rate rises
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Around one-in-ten of today’s
mortgagors sit within both of these groups, meaning they
are likely to have limited
ability to insulate
themselves against rising
rates
These borrowers are perhaps most
‘at risk’ Source: Modelling based on DWP, Family Resources Survey
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Afford
abili
tyHighly geared households in 2014
(base rate at 0.5%)
1,130,000
13%
2,330,000
27%
Re-finan
cing
Very low equity households in
2014
Afford
abili
tyHighly geared households in 2014
(base rate at 0.5%)
Highly geared households in 2018
(base rate at 2.9%)
760,000
9%
2,760,000
33%
At ris
k Highly geared in 2018 and potential
mortgage prisoners in 2014
Re-finan
cing
Very low equity households in
2014
Other non-standard circumstances
in 2014
770,000
9%At ris
k Highly geared in 2018 and potential
mortgage prisoners in 2014
#ukdebt
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This ‘at risk’ group is particularly prevalent in Northern Ireland and in London
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Large house price falls
mean that we might expect
more ‘prisoners’ to
live in Northern
Ireland
But affordability is a bigger issue in London due to the amount
borrowers stretched
themselves pre-crisis Source: Modelling based on DWP, Family Resources Survey
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And the problem is relatively concentrated among borrowers with low to middle incomes
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Vulnerability to the double
exposure of gearing and
prisoner status falls across the
income distribution –
worrying because we
might expect those with the
lowest incomes to have most
difficulty coping with
rising bills Source: Modelling based on DWP, Family Resources Survey
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Of course, actual outcomes will depend on the sequencing of income rises and rate increases
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Looking at wider (secured
and unsecured)
debt repayments, an optimistic scenario for
incomes and rates suggests
that the number in ‘debt peril’
might double by 2018
Source: Modelling based on ONS, Living Costs and Food Survey
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With ‘bad’ income growth and a modest interest rate shock having very significant consequences
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Under a much more
pessimistic (but still
plausible) scenario, the proportion of households in
‘debt peril’ would jump to
around 7%, more than
triple the baseline level
Source: Modelling based on ONS, Living Costs and Food Survey
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We haven’t experienced the debt crisis many envisaged in 2008; is it still to come?
• Ultra low interest rates, lender forbearance and government support have provided breathing space, but the underlying problem of affordability remains
• Focus has been on fixing the flow of new borrowers, but stock issue still needs resolving
• Unwinding of emergency measures is inevitable, but requires the same level of co-ordinated policy response as was seen in post crisis years
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#ukdebt
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Dealing with the debt overhang will not be costless, but there are policy options
• Tread carefully with rate rises • Rates must rise, but much debate around timing, pace and magnitude
• Sequencing of rate rises and recovery in household incomes crucial
• Make the most of the window while it remains in place • Borrowers need to insulate themselves against rate rises
• Requires signposting, market options and support for ‘prisoners’
• Prepare for a rise in repayment problems • Need to ensure capacity to deal with rising demand for debt advice
• Need to tackle social and economic upheaval associated with an increase in repossessions
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Dealing with Debt The prospect of rising interest rates
and the UK’s household debt problem
#ukdebt
Adair Turner – Senior Fellow, INET
Katie Blacklock and Matthew Whittaker –
Resolution Foundation
Gavin Kelly (Chair) – Resolution Foundation
3 June 2014