Credit crisis: the cracks are opening in UK’s debt mountain - Times Online

Since at least the turn of the century, the twin booms in the housing market and the high street have seen Britain’s seemingly unstoppable army of consumers spending with abandon. In a “What the hell?” culture of “Buy today and worry tomorrow” that has gripped the nation, households have run up mountainous debts that now total £1.4 trillion.

But has that “tomorrow”, and a grim day of reckoning, finally arrived?

Millions are already feeling the squeeze from soaring utility bills, higher taxes and only modest growth in take-home pay. Now, the financial screws on Britain’s households are being turned still tighter as the global credit crunch leads banks and other lenders to ratchet up their rates for remortgaging and for new loans.

Although most people will get by, millions will struggle and hundreds of thousands will suffer financial trauma. And for the unlucky and unwise who have overextended themselves in the good times, economists fear that things may be about to turn truly ugly.

Economists have given warning that the high levels of debt in the UK are actually magnifying the effects of the credit crunch.

Households in the UK owe a total of £1.4 trillion to banks and building societies. More than £225 billion has been piled on to credit cards and personal loans while the remainder has been spent on bricks and mortar, the Bank of England says. Even the start of the credit crunch last year was not enough to stem the credit binge. Credit card borrowing rose by 1.25 per cent last year, while mortgage borrowing rose 10.8 per cent, figures from Experian, the credit reference agency, show.

However, bigger debts mean that households become more sensitive to any change in interest rates. Even the slightest increase can eat up a significant chunk of their weekly income.

In 1998, when the bank base rate was as high as 7.5 per cent, the average household spent 9 per cent of its annual income on paying interest charges on its home loan, credit card, loans and overdraft. Today the base rate is only 5.25 per cent, but households are spending 10 per cent of their income on interest payments.

George Buckley, UK economist for Deutsche Bank, said: “The higher the debt levels, the more sensitive consumers are to changes in interest rates.”

The added difficulty is that while the bank rate has fallen in recent months, borrowers are being forced to pay higher rates for their home loans as lenders pass on the increased costs of borrowing money from other banks. The margin between the bank rate and “swap rates”, the rates banks charge each other, hit 1.2 percentage points last month, Usually this figure is around 0.23 percentage points.

Higher rates on new fixed-rate deals will force the 1.4 million people coming to the end of a fixed-rate deal this year to find an extra £100 a month on average, or £1,200 a year, simply to cover their repayments. In addition, they will have to find about £1,000 to cover the mortgage fee.

Although this will be an uncomfortable addition to the monthly bills, experts point out that many homeowners have built up a cushion of equity in their property which they can draw upon if the bills start to bite. The total equity held in property was £2.8trillion last year, compared with £1.2trillion of mortgage borrowing.

Those who who have had little time to build up equity in their property, or those who have remortgaged to release big slices of equity to fund their spending will be hardest hit. Lenders have withdrawn many deals offering more than 90 per cent of the value of a property, and only nine lenders still offer 100 per cent mortgage deals. As competition between lenders for these types of deals shrinks, the interest rates increase. The number of mortgages on offer has more than halved from about 13,000 in July last year to 6,100 today. As a result, borrowers will have to pay more to secure a new deal, or go onto their lenders’ more expensive standard variable rate.

Recent falls in house prices will only add to their woes. Spiralling house prices in the past decade resulted in many first-time buyers stretching their finances to the limit to buy a home. This, reasoned borrowers and lenders alike, would be fine as interest rates were low and house prices continued to climb, providing a pool of equity that they could use as a “Get out of Jail Free” card.

This worked for borrowers who bought two years ago. They have seen their house’s value soar by 20 per cent, giving them a reasonable cushion. However, people who bought a home with little or no deposit after September last year have limited wiggle room.

Tens of thousands of borrowers have already contacted debt charities for help this year. The number of people seeking help on mortgage arrears soared by more than a third in the first two months of the year, Citizens Advice said yesterday. About 144,000 borrowers were between three and six months in arrears with mortgage payments last year, figures from the Council of Mortgage Lenders show.

Another debt charity said that the number of people becoming insolvent is set to rise this year as Britons try to keep up with the spiralling cost of living. Vince Cable, the deputy leader of the Liberal Democrats, has given warning of a “very real possibility of mass bankruptcy and repossession across the country”.

More borrowers could be thrown into difficulties by the abrupt withdrawal of credit. Last month, Egg, the online bank, cancelled the credit cards of 161,000 customers with little warning. Those relying on juggling their debts between credit cards will face an uphill struggle as lenders become more picky about their customers. They may face the prospect of actually repaying the debt or accepting punitive interest rates on their borrowings.

A spike in insolvencies is bad news for the economy, but a potentially more damaging side-effect of the credit crunch is the slowdown in spending among consumers as they strive to meet their increased monthly repayments. The stalling housing market is likely to exacerbate this. Jonathan Loynes, UK economist for Capital Economics, said: “The housing market oils the wheels of consumer expenditure as homeowners buy goods for their new houses.”

Consumer spending accounts for two thirds of economic activity, and economists have sounded alarm that any slowdown in this area and the subsequent drop in demand could prompt redundancies. Mr Loynes said: “A cut-back in employment could then cause a further slowdown in spending. There is a real danger that these things feed back into themselves.”

Howard Archer, of Global Insight, said: “The longer the crisis goes on, the more people will be sucked into it.”

Debtor nation

— The average credit card holder has a balance of £1,856 on their cards, according to Uswitch, the price comparison website

— The average outstanding mortgage is £100,406; the average first-time buyer borrows £117,999 and spends 20 per cent of their income on mortgage interest payments

— Consumers in Northern Ireland increased their borrowing by nearly a quarter over the past 12 months, the biggest increase in the UK

— Borrowers in Aldershot, Dartford, and Ilford have reined in their spending most, according to Experian, the credit reference agency

— Nearly 25,000 people became insolvent between October and December last year, 16.4 per cent fewer than the same period in 2006. The major reason for that was a spat behind the scenes between lenders and companies offering Individual Voluntary Arrangements (IVAs) – schemes that allow debtors to pay off only a portion of their debts. Borrowers who take out an IVA must repay at least 35 per cent of their debt

— Lenders refused to accept many IVA applications, saying that IVA firms were offering payments that were too small and taking high fees for themselves. The dispute was resolved last month, so experts expect the number of IVAs to soar in the coming months

Credit crisis: the cracks are opening in UK’s debt mountain - Times Online
The buy today and worry tomorrow culture that has gripped the nation in recent years threatens to make UK households particularly sensitive to the global credit crisis