Why has debt Increased in the UK?
- UK debt currently stands at over £1.1 trillion.
- Average Personal Debt (Credit Card, overdrafts and personal loans) = £3,170
- note in Europe average personal debt only accounts for £1,588
- Average Mortgage debt = £21,000
- (note this is much higher than European Average) (Source 1)
Causes of Increased UK Debt
1. Lower Real Interest Rates.
Compared to the 1980s long term interest rates in the UK have fallen. For example, in 1992 interest rates reached a peak of 15%. During the past 10 years the average interest rate has been around 5%. (In 2005 they reached a record low of 3.5%.) Lower interest rates makes borrowing cheaper. Due to the Bank of England's independence people now expect lower inflation and hence lower interest rates. The B of E now set interest rates and have been relatively successful in keeping inflation within the government's target of CPI = 2%. Therefore with inflation under control, there is less need for interest rates to rise as suddenly as they did in the late 1980s, Lawson boom.
2. Changing Social Attitudes to debt.
In previous generations saving was praised as a virtue; thrift and conservatism were seen as good things. In modern society the idea of borrowing is much more prevalent. This is due to a combination of factors, which are hard to separate; however, one significant reason is the increased availability of credit.
3. Increased availability of Credit
In the past 2 decades the financial service markets have been liberalised, increasing competition between lenders. This has enabled an increased choice of loans and credit cards. Therefore an increasing number of people have taken advantage of services like, interest free overdrafts and credit cards. For example, credit cards with introductory fees of 0% have made borrowing cheaper and more attractive.
4. Changes in Mortgage lending.
The Major mortgage lenders have relaxed their criteria for lending money. In the past they used to use a strict income multiple; for example a maximum loan of 3 times income. Now some major banks are willing to lend upto 5 times income. In addition, there are new types of mortgages which have enabled first time buyers to get larger mortgages. These include interest only, 50 year mortgages and increased use of self certification mortgages.
5. Chip and Pin.
Financial Service group uSwitch argues the introduction of chip and pin credit card machines have increased the willingness of consumers to take out extra cash on credit cards - this is despite the high interest charged on these cash withdrawals. Cash withdrawals on credit cards totaled £5.4 billion last year (2)
6. Greater Political and Economic Stability.
The UK has witnessed a long period of political stability. Since 1992 the economy has avoided a boom and bust situation. Therefore memories of a recession in the UK are fading; people are more confident and don't expect things to go wrong. This is an important reason for increased willingness to borrow.
7. Booming Housing Market.
The continued strength of the UK housing market is a significant factor in maintaining the increased levels of debt. Most measures of house prices suggest house prices have doubled in the last 5 to 6 years. Rising house prices enable increased debt, because people can take out secured loans against the value of their houses. In addition mortgage equity withdrawal has been increasing; mortgage equity withdrawal occurs as consumers take advantage of rising wealth to enable higher spending.
8. Poor Information on Financial Details
Leading experts from CRESC argue that many consumers have poor information about the debt they are getting into. Many consumers with high levels of debt may not even be aware of their debt levels and the interest they are paying. Professor Williams comments that "Most people don't have the competence to deal with complicated financial problems and would have difficulty explaining even APR (annual percentage rate of interest)". He goes onto say that financial illiteracy is a major factor behind increased debt levels (3)