AS Macro Revision: Consumer Borrowing

Most of us at some time need to borrow money to finance spending. From taking out a mortgage or using a student loan and making frequent use of bank credit cards, borrowing is a normal feature of life and not necessarily something to be worried about. What matters is whether building up debt is sustainable – in other words, can those who rely on debt pay it back? Huge levels of borrowing and an inevitable surge in household debt were features of the long period of growth that came to an end in 2008. Now the British economy is being held back by a historically high level of consumer debt - and you thought that it was the British government stuck in the deepest debt trap?

Credit means being able to buy now and pay later. The credit market for individuals is complex at the best of times and there is plenty of scope for individuals to end up in trouble if they borrow irresponsibly or are subject to mis-selling of loan products from the financial services industry.

Broadly speaking we can distinguish between:

Unsecured borrowing – that is a loan or an overdraft which is not tied to the value of another asset. Good examples of this are student overdrafts, bank loans and money borrowed on store and credit cards

Secured borrowing – is lending where the borrower must use another asset as collateral for the loan. The best understood example of this is a mortgage with a bank or building society. Home buyers are at risk if they fail to keep up with monthly mortgage repayments and ultimately, the lender may foreclose and seek a repossession of the property.

Without question, one of the most important features of the British economy in recent years has been the high levels of borrowing. Many billions of pounds were added to credit card debts and the scale of re-mortgaging in the housing market has been huge. In March 2010 total UK personal sector debt stood at £1,460bn. Total consumer credit lending to individuals at the end of March 2010 was £222bn. Average household debt in the UK is £57,950 (including mortgages).

To use a technical term, what we have seen is a ‘leveraging up’ of the consumer sector – which in lay person’s terms means that people seem to have been happy to increase the ratio of their debt to income. Indeed, such has been the scale of the borrowing binge, that the UK has one of the highest debt-to-income ratios of any of the leading economies.

As our chart shows, the borrowing boom has come to an end. Mortgage equity withdrawal has tailed away, credit card lending is slowing down and the annual growth of all consumer borrowing has declined.

One key reason is that credit is harder to come by especially in the mortgage market - many lenders have tightened the conditions that need to be met before a loan is given out

Secondly with rising unemployment and worsening job security people are cutting back their loans and seeking to rebuild their own balance sheets by saving more and spending less

Thirdly despite record low interest rates from the Bank of England, the cost of unsecured loans such as an overdraft has actually increased. Indeed the ratio of the interest rate on loans and the policy interest rate from the Bank of England has surged to over thirty - borrowing money is tough and it is expensive and this is one reason why low interest rates have had only a muted effect on the level of aggregate demand during the recent recession.