Up to 2 million UK families face perilous debts by 2018

Britain faces the mounting prospect of a household debt crisis as analysis from independent think tank the Resolution Foundation suggests that a least a million British families, and possibly as many as 2 million, could be spending more than half their disposable income on repayments by 2018

The study uses the latest five-year growth projections from the Office for Budget Responsibility to model how the number of households in ‘debt peril’ may rise over the same horizon – depending on the path of interest rates and the shape of growth in household incomes.

On the most adverse, but still plausible, scenario looked at in the Resolution Foundation analysis the number of households in Britain who spend at least half their disposable income on repaying debts (and are therefore deemed to be in debt peril) could more than triple – from 600,000 in 2011 to 2 million by 2018. This could happen if interest rates were to rise to 5 per cent – two points higher than the current market expectation but still around typical long-term levels – and if growth in household income was weak and uneven (lagging behind GDP growth and more skewed towards higher than lower income households).

Even under a more optimistic scenario, in which interest rates do not rise above 3 per cent by 2018 and in which household incomes grow more strongly than the OBR has projected and is distributed relatively evenly across high to low income households, the number of families in debt peril would almost double – to 1.1 million.

Currently most analysts expect interest rate rises to start in 2015 though recent sharp falls in unemployment, bringing it closer to the 7 per cent threshold at which the Bank of England may consider raising rates, has led to speculation there may be pressure to raise rates later in 2014. The Resolution Foundation analysis suggests a sharp increase in the number of households exposed to very high levels of debt by 2018 – on any economic scenario that looks likely given the latest official forecasts.

This would mean Britain reaching higher levels of perilous household debt than those in 2007, just before the financial crisis. The number of households in ‘debt peril’ (spending more than half their net income on debt repayments) stood at 870,000 in 2007, just before the crash, but had fallen to 600,000 by 2011 as interest rates plummeted and households deleveraged during the recession.

These increased household debt levels would have profound implications for households, banks and policy makers and for the wider economic recovery. The Resolution Foundation analysis is still based on cautious assumptions, such as GDP growth rising in line with the OBR’s projections, household debt growing as expected by the OBR to around £2.2 trillion by 2018, and the spreads between market interest rates faced by borrowers and the Bank of England rate falling halfway back to their historic levels. 

The new Resolution Foundation analysis also comes in the light of a report from the Bank of England based on a survey by NMG Consulting which warned that homeowners with heavy debts could become overburdened if interest rates start to rise before household incomes pick up. Separate findings from the Bank’s Financial Stability Report in November showed that household debt could rise substantially over the next 20 years – using a measure which could see it increase to almost 140 per cent of incomes compared to the current 100 per cent.

With few able to say with confidence what interest rates will be in 2018, the Resolution Foundation findings also stress how little freedom for manoeuvre the Governor and Monetary Policy Committee may have if the squeeze on household incomes continues and external factors—or a domestically generated housing boom—generate pressure for higher rates.

The Resolution Foundation study suggests that while interest rates remain at an all-time low, policy-makers have a window of opportunity in which to consider how best to pre-empt a future repayment crisis for those households which are likely to be vulnerable but viable. The scenarios outlined in the report are not predictions because the shape of the economy in 2018 cannot be known with certainty. Rather, they are models built on existing data relating to household debt on the best available forecasts of the future.

SCENARIOS IN FULL

The new analysis also looks at two main scenarios for household income growth in the recovery, and at a range of possible interest rate rises in each case:

• A ‘good growth’ scenario in which household income growth is strong and shared (tracking GDP and being shared evenly between poor and rich households). In this optimistic scenario – which would be a marked departure from recent experience – if interest rates rise no higher than the 3 per cent the market expects, the number of households in debt peril rises to 1.1 million by 2018. If interest rates instead rise 1 percentage point more than expected by 2018, the number of household in debt peril rises to 1.4 million. If interest rates rise by 2 percentage points the figure rises to 1.7 million.

Under this scenario the total numbers of households who would be debt-loaded – defined as spending more than 25 per cent of their disposable income on repayments – ranges from 5.5 million to 6.4 million depending on the path taken by interest rates.

• A ‘bad growth’ scenario in which household income growth is slower and uneven (falling behind GDP growth and being focused more on rich households). In this scenario, the number of households in debt peril rises to 1.4 million even with interest rates at 3 per cent in 2018. The figure rises to 1.7 million if interest rates rise 1 percentage points above expectations by 2018 (to 4 per cent) and to 2 million with interest rates at 5 per cent in 2018.

The analysis also shows that the poorest 20 per cent of households are much more likely to be in debt peril. Under this ’bad growth ‘scenario the percentage of those with perilous levels of debt in the bottom fifth of the income distribution rises from 5 per cent in 2011 to 9 per cent in 2018.

Under this scenario the total number of all households which would be ‘debt-loaded’ – ranges from 6 million to 6.6 million depending on the path taken by interest rates.

The findings are based on original analysis by the Resolution Foundation using OBR projections, the Living Costs and Food Survey dataset and historic trends for household income growth. Baseline forecasts for the total level of household debt and interest rates are taken from the Office for Budget Responsibility forecasts published on 4 December 2013. The findings enlarge and update an earlier version of this analysis which was based on older OBR forecasts and which looked only ahead to 2017.

Matthew Whittaker, senior economist at the Resolution Foundation, said :

“Even if we take a somewhat rosy view of how the economy will develop over the next few years the number of households severely exposed to debt looks as though it will double. But the levels of debt built up by families in the pre-crisis years are such that even relatively modest changes in incomes and borrowing cost assumptions produce significantly worse outcomes.

“This is an alarming prospect, where a large number of families find themselves struggling with heavy debt commitments, especially among the households who are already among the worst-off. As the Bank of England has acknowledged, even small increases in the cost of borrowing could push a significant number of families over the edge and it’s most likely to happen to those with the lowest incomes – who are already spending the biggest share of their budget on repayments

“The point at which interest rates start to rise is still likely to be some way off. But we can’t afford to wait until monetary tightening becomes an inevitable prospect before we attempt to deal with the debt overhang that remains in place. Rather than waiting for a repayment crisis to strike, policy makers and lenders should seriously consider acting now while there’s still the chance to help people reduce their exposure to debt.”

Gavin Kelly, chief executive of the Resolution Foundation, said:

“There is huge uncertainty about income growth and interest rates but under almost any plausible scenario there is going to be a big spike in the next Parliament in the number of households facing crushing mortgage payments. We could well be talking about this issue as much as we are currently discussing wages or energy bills. As yet there is little sign of the political or financial establishment giving this the priority it deserves.”

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