New Consumer Credit Report Warns of Unsustainable Mortgage Debt with UK House Prices 28% Too High

LONDON, May 19, 2014 /PRNewswire/ --

• Total household debt up 314% from £347bn in 1990 to £1,437bn in 2013
• Recovery fragile: bank base rate of 3% would tip UK back into recession
• 0.5% increase in base rate would spark a £4.8bn reduction in spending

A new report on consumer credit by independent research company Verum Financial Research says the UK economy is risking a major downturn due to unsustainable levels of household debt.

Describing the recovery as 'extremely fragile', the Verum Consumer Credit Trends Report for May 2014 has calculated that every 0.5% increase in the Bank of England base rate would result in a £4.8bn reduction in household spending. If the base rate increased to 3% it would tip the UK economy back into recession.

Professor James Fitchett, of Leicester University School of Management, says in a foreword to the report: "The main problem facing the UK economy is therefore now a problem concerning consumer spending and debt. As these data show in considerable detail, the prospect of even slightly higher marginal lending rates could have a catastrophic effect on the economy."

The Verum report warns that household debt remains unsustainably high due to spiralling mortgage debt. Total household debt increased by 314% from £347bn in 1990 to £1,437bn in 2013, of which 89% was mortgage debt. House prices increased by 318% over the same period, while household incomes have risen by only 203%.

Robert Macnab, Verum's director of research, said: "This elevated level of mortgage debt is unsustainable. In a stable housing market, house prices should grow at the same rate as household incomes so that periodic 'booms and busts' are avoided. So unless wages increase quickly, which is unlikely, our analysis of the relationship between household incomes, debt and property prices indicates that UK house prices are currently over-valued by 28%. The average should be nearer to £180,000 and not £250,000 as it is at present¹.

"This 'debt spiral' threat to the economy is compounded by the increased cost of living which, combined with a real terms drop in income, is restricting households' ability to reduce debt. Following the 1990 recession non-discretionary spending (essentials such as housing, food and fuel) fell steadily, from more than 55% of gross income to less than 50% by 1995. It stayed below 50% until 2004, when interest rates began to increase, topping 55% again in 2008. Since 2009 it has hovered just below the 'recession risk' level.

"With household finances under such pressure, any rise in the abnormally low interest rates will have a negative impact on consumer spending. Our research has identified an important threshold when 12% of household disposable income goes to servicing debt interest payments. At this level households cut back significantly on discretionary and often credit-sensitive purchases (such as vehicles, holidays, durable goods and furniture), a scenario which would bring the recovery to a grinding halt. To reach this 12% threshold, base rates would only need to rise to 3%. If mortgage rates followed suit, which they invariably do, the housing market would experience a sharp correction."

Notes To Editors 

Robert Macnab is available for interview.

Excel data file and Main Findings & Conclusions document - with graphs illustrating the close correlation between household debt and house prices (Fig.2) and the 'recession zones' for both non-discretionary spending as a % of disposable income (Fig.5) and interest payments as a % of disposable income (Fig.7) - available on request.

Verum's analysis of consumer credit, debt and household incomes is based on a detailed analysis of official data including data from the Office for National Statistics and the Bank of England. The report also analyses data on debt write-offs by UK banks and building societies, consumer insolvencies and mortgage arrears and repossessions.  

1990 is used as the base or reference year for the analysis of credit trends because this is the last occasion of a significant house-price correction as a result of the 1990/1991 recession when interest rates reached 14.6% in 1990.

¹ONS average UK house price data: House Price Index annual tables 20-39 (Table 22 Housing market: house prices from 1930, United Kingdom).  This shows the relative change in prices 1990-2013.  The aim of the ONS House Price Index (HPI) is to measure the change in the average house price for owner-occupied properties in the UK, its component countries and regions.  The index is constructed from transacted property prices and is calculated on a monthly basis.  The index is chain linked to produce an index series that allows comparisons to be made across years.

For a detailed explanation of the methodology used by the ONS to compile average house prices please see section 3. ONS HPI methodology of the PDF document 'Official House Price Statistics Explained' at the following address: http://www.ons.gov.uk/ons/guide-method/user-guidance/prices/hpi/official-house-price-statistics-explained.pdf

Verum Financial Research is a trading division of Zabuloe Limited. As an independent research organisation, it relies entirely on sales income from its published research. It is not sponsored or commissioned by any third party. Verum employees are members of the UK Market Research Society (MRS) and all research is carried out in accordance with the MRS professional code of conduct.

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