A House of Cards

Alongside the strong rise in wealth creation seen over the last decade, debt levels have risen to new heights, with total consumer credit now standing at £1.35 trillion of which £215bn is unsecured — a doubling in a decade. As interest rates rose over 2006/07 concerns about borrowing levels rose too; with the economic outlook now looking shakier than at any time since the recession of the early 1990s, personal debt levels have become of even greater concern. Bank of England interest rate decisions have a substantial public following.

A recent study by the Personal Finance Research Centre at Bristol University — Easy come, easy go: borrowing over the life-cycle* — makes interesting reading in this respect. House price rises that have often seemed as if they could not stop, are partly responsible for driving borrowing requirements, as are the availability of easily accessible and apparently cheap mortgages.

High mortgage debt has affected young adults getting onto the housing ladder and is compounded for many by the costs of university tuition fees. The family age group, mid 20s to mid 50s, is affected by increased costs of pension provision and the high costs of having families. And there is emerging evidence that levels of borrowing among people moving into retirement may be higher now.

One of the most interesting findings of the study is that, despite the ever easier accessibility of consumer credit, the proportion of the population actively borrowing remains largely unchanged over the last decade at around a half, with a further quarter having credit facilities but remaining debt free. The almost doubling in consumer credit is therefore being carried by the same proportion of the population, placing them at much greater risk in the event of an economic downturn.

Of those with credit commitments, 42 per cent had only one, 25 per cent only two, 15 per cent had three, seven per cent had four and ten per cent had five or more active credit commitments — representing about four per cent of the total population. Other surveys have confirmed that the use of heavy credit is concentrated amongst a tiny minority, but many more are carrying a lot more debt than they should.

So why are people borrowing more? The research found that attitudes to borrowing were a greater influence on borrowing decisions than age, family status, income level, drops or drops in income. And that attitudes have changed. Previous research has tended to identify two distinct reasons for borrowing: either to alleviate hardship or to service consumerism. This research shows that the distinction between these has blurred in the minds of many young adult and family years borrowers; for some young adults, the two are almost indistinguishable.

People in older age ranges have broader perspectives on borrowing: they have seen a number of recessions and falls in house prices; many experienced the austerity of the 1940s and early 1950s and have lived much of their lives in the absence of readily available credit. Though people in the family years have witnessed economic downturns, they seemed to either have forgotten the effects of that or downplay its relevance today. There is a sense that housing equity is a good form of investment, but that mortgage borrowing is itself a good investment. As such there is little concern about taking on large mortgages and re-mortgaging to release cash for other purposes.

This is to some extent expressed in the range of items people are prepared to borrow; the post family age group typically will contemplate borrowing only for one-off, large items like medical care. In contrast, young adults are borrowing for a wide range of items, from cars to meals out, with these borrowing choices being seen am amongst family years to a lesser extent.

Unsecured borrowing, like mortgages, is seen as cheap and with few barriers to accessing it. Many people respond to this perception of cost and the reality of accessibility by borrowing. Yet a number of misconceptions around the costs of credit exist. Many young adults, and some by their own admission, have little idea of how credit works — one young man who took part in the study had been using credit extensively for some time to buy and do-up cars to sell, and make a profit, before he learnt what APR was.

A further area of misconception — for a significant minority — is that getting out of problems of over borrowing through loan consolidation and debt write offs through IVAs is easy and relatively painless.

There is also evidence of people conflating them; one young man said, ‘there’s some government clause where you can write off a certain amount of your debt and then because you’re paying just one rate of interest to one company it works out a lot, lot cheaper.’ Another says: ‘My mate borrowed £50,000 and though he has nothing to show for it now he had a good time on it.’ It combines the worst of thinking that borrowed money is their own, and thinking it is someone else’s money to spend and so not have to pay back.

Well handled, credit allows people to smooth over the ebbs and flows of income and outgoings, but the more consumer credit commitments people have, the greater the odds of them falling into arrears not only on credit commitments themselves but also on utility bills and other essential household commitments. This is true during times of steady income but it is even more likely when income drops or if costs suddenly rise, whether temporarily or not.

Moving home, birth of a child, relationship breakdown, job loss, drops in income, onset of illness, disability — all of these can trigger the onset of financial difficulty. They are hardly absent from the lives of young people, indeed, job instability and other factors have a very high incidence, yet there is little awareness of the risk of changed circumstances on income.

The evidence is that attitudes to borrowing money are more influential in determining borrowing than age, family status, income level or drops in income — though the changing nature of demands on people and their income are clearly influences too, with borrowing still peaking, as it has for decades, between the age of 25 and 50.

Other survey evidence suggests that young people welcome external limits being placed on borrowing — indeed, in the absence of ‘financial literacy’, they rely on red letters to keep them in line; older people, in contrast, typically tend to worry more than necessary, making their own credit boundaries tighter than the credit companies.

So young adults can be expected to respond well to external limitations on their credit use, but they also need financial education and the wisdom to navigate the consumer culture.

The key drivers of borrowing that come unmistakably from the research are the heightened expectations of living standards with each generation, the influence of the consumer culture and lack of self-control. Considering the wide availability and accessibility of credit, it it perhaps not surprising there seemed little motivation to reduce or avoid borrowing except in very limited circumstances.

For the family age group, the biggest problem is the idea that housing equity is a financial cure-all for debt, lack of pension and so forth. People need to be realistic about the roles housing equity can play. Ownership is not sufficient to ensure proper financial provision as this group heads into retirement.

So what can government and the financial community do? There need to be more incentives to save and methods of saving, as well as a much more coherent approach to financial education throughout and beyond the school years, with specific attention given to making sure that pupils understand the real costs of credit.

There must be a rigorous approach to challenging and creating an alternative to the ‘want it now’ culture. Perhaps all school children should have a savings account as part of their financial education, providing an opportunity for them to practice what they are taught. For adults, one important shift would be for them to come to see their credit report as theirs, something they access regularly and seek to manage, rather than a tool of lenders over which they have given up all control.

Duncan Hadfield is a senior researcher at Parliamentary Brief.

*The study was carried out by Andrea Finney, Sharon Collard and Elaine Kempson from the Person Finance Research Centre, with the support of Standard Life.