When Is Household Debt A Problem?

On debt, it’s vital to go beyond headline measures
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Recent years have seen growing concern about the amount of unsecured debt held by UK households. On the Bank of England’s measure, the total size of this sort of debt – which includes credit card debt, unsecured loans from banks, and car finance debt – has been growing at around 10% per year in last few years, and now stands at over £200 billion. Lots of this debt is held by a relatively small group of households – 10% of households have debts of £10,000 or more and that same 10% holds 70% of all outstanding consumer debts.

As the Bank has noted, the growing size of total unsecured debt could pose risks to financial stability. But knowing the total amount of household debt doesn’t tell you very much about the impact on people’s living standards. Much debt is sensible and manageable – households borrowing to fund one-off purchases or to smooth out spending during changes in income. In fact, more than half of all unsecured debt is held by households with above-average incomes, and more than half of households with debt have enough financial assets (e.g. money in savings accounts) to pay them off. The challenge is to identify when debt looks more problematic. New research by the Institute for Fiscal Studies draws on a large amount of data on households and their debt holdings to try to do exactly that.

Who looks to be struggling with debt?

Debts can have a immediate negative impact on household living standards when debt repayments take up a large share of income – crowding out spending on other goods and services households might want or need. To identify households that may be under pressure in this way, we classify a household as under “immediate debt servicing pressure” if it is spending more than 25% of its monthly after-tax income on servicing its debts or if it is in arrears of two months or more with a bill or credit agreement

On this measure, about one in eight individuals is in a household under servicing pressure.. The proportion of individuals who look to be struggling with debt is higher amongst those with lower incomes, at one in four individuals in the bottom income tenth. This is because they are more likely to be making large debt repayments compared to their income and because they are more likely to be in arrears.

We might well be more concerned about low income households that are spending a lot on debt servicing for the simple fact that the kind of things these households cut back on are likely to be more important for living standards. But there are two further reasons to be more concerned about those on lower incomes who are facing this kind of pressure. First, lower income households under servicing pressure are less likely to have significant financial assets – such as current and savings accounts, bonds, or stock and shares – that could be used to meet their debt payments. Second, those with lower incomes are also more likely to remain under servicing pressure once they are there.

Younger individuals look to be more at risk of struggling with debts. 16% of 25-29 year olds are under servicing pressure compared to just 3% of 75-79 year olds. Low-educated young adults (those who left school at age 16 or below) are particularly likely to be struggling. Despite holding smaller amounts of consumer debts than those young people who stayed longer in education, they are more likely to be in households that are in arrears and tend to have types of debt (e.g. hire purchase and mail order) that need to be repaid more quickly. These may be the sorts of individuals and debts on which policymakers want to focus their attentions.

The detail matters

When thinking about household debt, figures about total debt holdings are no guide to the scale of “problem debt”. It’s vital to go beyond headline measures and look at who holds debt, the circumstances in which debt arises, and distinguish between debts that look entirely sensible and those that look unmanageable. When you do this, you find that most unsecured debt is held by high income households who look able to manage it, but debt looks like a real problem for a significant number of those on low incomes.

Andrew Hood is a Senior Research Economist at the IFS
David Sturrock is a Research Economist at the IFS


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