Britain's borrowing binge

Was the Bank of England right to keep interest rates on hold this month given the levels of consumer debt in the UK? Simon Nixon reports.

How deeply in debt are we?

Britons owe £934bn - or £15,884 for every man, woman and child - and borrowing is expected to reach £1trn later this year. The overall household debt-to-income ratio has reached a record 129% of GDP. Unsecured personal lending, which includes credit-card borrowing, accounts for over 30% of all borrowing and the average adult owes £1,104 on their credit card. But the main component of overall debt is mortgage borrowing, which has reached £780bn, 140% higher than 12 years ago.

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Why is debt rising so fast?

Largely because opportunities to borrow are so much greater. More people have access to credit these days, interest rates are low, so loan repayments as a proportion of income do not seem huge. The big rise in mortgage debt also reflects the sharp rise in house prices, one explanation for which is that easier access to mortgages has fuelled demand for housing. Fortunately, the people who owe the most are generally the people who can best afford it, according to the Bank of England. Only 6% of the lowest-income earners had credit-card debts outstanding, while a relatively large proportion of the population is actuallydebt-free. The only group for whom average debt had risen since 2000 were those earning more than £17,500 per year.

Is this a problem?

Not necessarily, despite the huge publicity given to tragic cases such as that of Stephen Lewis, who killed himself after running up credit-card debts of £65,000 on a £22,000 salary. Bankruptcies, up 12% to an 11-year high in the fourth quarter of 2003, are still too few to be a real problem. All the main measures of debt delinquency - home repossessions, mortgage arrears, credit-card arrears - are at historically low levels. It's hardly surprising: with interest rates so low, debt-servicing costs currently equal 7% of average income, compared to 15% in the early 1990s.

Why might it be unsustainable?

Some economists argue that it is misleading to focus on the ratio of debt servicing costs to average income, since this fails to take account of the cost of repaying the loan itself. If this is added, the debt burden relative to income is higher. Even so, household debt as a proportion of financial assets (called capital gearing) has fallen in the last year, thanks to house price and stockmarket growth. Yet Sir Andrew Large, deputy governor of the Bank of England, is worried that, if interest rates rise in line with market expectations, capital gearing will hit levels last seen at the height of the 1990s market boom within two to three years.

Should the Bank of England be worried?

Yes, says Sir Andrew. He thinks that there's a house-price bubble, which, if it bursts, will create widespread financial instability as borrowers default on their debts. But his colleagues on the Monetary Policy Committee are not convinced that there has to be a crash. The Netherlands and Australia both saw house-price rises slow, not fall, after a period of rapid growth. Besides, there are important differences between now and the early 1990s: inflation is low and unemployment is falling. Even if capital gearing rises to the levels Sir Andrew fears, this need only be a problem if interest rates or unemployment were suddenly to rise much higher than anyone currently predicts.

What effect would rising interest rates have?

In theory, higher interest rates should lead to a slowdown in the growth in borrowing and spending. But much depends on the mix of fixed and floating-rate mortgages. The latest figures suggest that some 36% of borrowers are now on fixed-rate mortgages, and this figure is rising as customers take heed of warnings of rising interest rates. This suggests that many borrowers could take an interest-rate rise in their stride. A recent survey by internet bank Egg showed that 93% of borrowers felt "comfortable" with their debt levels and only 7% thought they might be over-stretching themselves. Meanwhile, there is growing evidence that the consumer boom is winding down. The Association for Payment Clearing Services reports that credit-card holders are paying off their debts faster than they are borrowing. Repayments in the year to the end of February grew 12.5% to £9.3bn, while spending rose just 7.3% to £9.7bn.