An unhealthy Interest? Debt distress and raising rates

1. Context
2. The study
3. Key findings
4. Points to consider

• Context
• The study
• Key findings
• Points to consider
• Full report

Context

With household incomes coming under even more pressure from rising inflation, household debt is again rising in certain sectors of the population. There are signs of debt ‘distress’ among some borrowers, with vulnerable groups particularly at risk. Following the rise in the Bank of England’s base rate in November 2017, there is concern that current consumer debt levels could rise quickly in the near future.

The study

The Resolution Foundation produced this insight in 2018. The report reviews the scale of household debt and ‘it’s recent surge’, before looking at debt levels by certain groups of people. A main focus of this work is to consider how household debt in the United Kingdom will be affected by increasing interest rates in the near future.

• The study describes recent trends in household debt, both before and after the financial crisis. Improvements made in the past few years are highlighted, alongside evidence of rising debt levels throughout 2017.
• The study considers the distribution of debt, discussing how different measures of debt ‘distress’ vary across the income distribution.
• Some predictions of the effects of future interest rates are given, showing who might be affected as well as considering the extent to which rising borrowing costs may cause problems for consumers and the wider economy.

Key findings

• Concerns regarding an increase in household debt have increased recently, with consumer credit back to the levels recorded just before the last financial crisis.
• However, the debt-to-household ratio, while increasing slightly lately, remains substantially down on the ‘pre-crisis’ peak, while costs associated with servicing household debt are back to levels from the mid-1990s.
• Post-crisis regulatory reforms have removed some of the worst lending practices that were commonplace before 2008. For example, the percentage of new mortgages advanced without any verification of applicant income has decreased from 46% in 2007 to less than 1% in 2017.
• Similarly, interest-only mortgages now make up just 19% of mortgages advances, compared with 49% in 2007.
• More concerning is that 6% of working-age households (1.2 million households) were suffering from three or more measures of debt ‘distress’ in 2017. For example, 21% said that they had struggled to pay for their accommodation in the last 12 months, while 17% reported being ‘very’ concerned about their level of debt.
• Almost half (45%) of lower income households reported at least one form of debt ‘distress’ in 2017.
• One-in-ten (10%) of working-age households are at risk of falling into arrears on their debts.
• Modelling suggests that a 2% rise in interest rates would increase average monthly repayments among mortgagors by £71.
• Under this scenario, the proportion of mortgagor households that spend 30% or more of their pre-tax income on mortgage payments (i.e. those ‘at risk’) would rise from 12% to 15% of households.
• Many mortgagors may face limited options when trying to remortgage. These ‘mortgage prisoners’ could face the prospect of being forced to remain on their existing lender’s standard variable rate as they cannot afford to move, which is important because these rates are more expensive than other variable and fixed rate deals that may be available.
• These ‘mortgage prisoners’ could be those with very little equity in their home, those who have high loan-to-income ratios, those with interest-only mortgages and the self-employed. The report estimates that ‘mortgage prisoners’ could account for 11% of all mortgagors in the UK.

Points to consider

• Relevance:
  • This report is of relevance to anyone with an interest in household debt levels and the likely impact on them by rising interest rates. It is a contemporary thought-piece that is hugely relevant at the moment, though will probably date quickly due to the rapidly changing borrowing landscape.
• Generalisability/ transferability
  • While this appears to be a well-researched report, it relies heavily on forecasting and predictions that the authors themselves recognise as unlikely in places. Caution must be taken when reading some of the key findings. However, this provides a well-researched snapshot of the link between household debt and rising interest rates.

Full report

An unhealthy Interest? Debt distress and raising rates - full report