Revision: Consumer Borrowing

Most of us at some time in our lives need to borrow money to finance spending. From taking out a mortgage to making frequent use of bank credit cards, borrowing is a normal feature of life and not necessarily something to be worries about. What matter is whether building up debt is sustainable – in other words, can those who rely on debt pay it back? 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 have been added to credit card debts and the scale of re-mortgaging in the housing market has been huge. 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

Secondly with rising unemployment and worsening job security people are paring back their loans and seeking to rebuild their own balance sheets

Thirdly despite record low interest rates from the Bank of England, the cost of unsecured loans such as an overdraft has actually increased.

A full set of AS macro revision notes is available here and our AS economics revision presentations can be found here