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Plastic, Lovely Plastic

UK consumers are in love again with their credit cards, says a new report from PwC. But how toxic is the renewed growth of unsecured debt?

This economic recovery we keep on hearing about had better be a good one, if the recent report from PwC about UK household borrowing is to be believed. UK households are already in the red to the tune of an average £8,936 in unsecured debts, and the total looks set to approach £10,000 by the end of next year.

PwC’s 46-page report, entitled “Precious Plastic: How Britons Fell Back in Love with Borrowing” is the result of a YouGov/PwC poll among 2,000 UK consumers, and it’s well worth reading in full – not least because the charts alone are eye-popping. (It’s available at http://tinyurl.com/m95wkpt.) But it’s the raw numbers that curdle the blood.

Borrowing At Record Levels

Last year alone, the report says, Britain’s total outstanding non-mortgage borrowing increased by £19.7 billion (9%), which was the fastest rate of growth not just since the recession started but also in more than a decade. That has left the debt mountain surpassing its pre-financial crisis peak, at least in nominal terms. And the bulk of that is on store cards, credit cards and personal loans.

But that’s just for starters. PwC is expecting another 4%-6% per annum growth over the next two years, which is where the £10,000 projection comes in. And the implication is that Britons may be setting themselves up for a wipeout if interest rates were ever to rise significantly.

At present, PwC says, consumers are being suckered into debt by abnormally low bank rates which don’t reflect the long-term likelihood at all. With the Bank of England base rate still stuck at its 2009 level of 0.5%, even the rather higher charges levied by unsecured lenders are strapped down to what we might consider to be unusually low levels, and as a consequence the future expectations they engender may have become unrealistic.

Even just a 2% rise in interest rates on total household debt (including mortgages this time) would mean that households needed to find an additional £1,000 a year for the servicing costs, the report says.

The Mortgage War Feeds Unsecured Demand

There’s good and bad in this situation. Total lending to consumers rose by over 2% in 2014 to £1.54 trillion – nearly twice the growth seen in 2013. But PwC says that the lion’s share of the increase in total borrowing was accounted for by secured lending, which increased from £1.28 trillion to £1.30 trillion as the mortgage market continued to recover.

So it wasn’t surprising that competition between mortgage lenders became increasingly intense – meaning that, alongside low funding costs, rising property prices and falling bad debt, the cost of mortgages to home buyers has declined sharply.

The bad news appears to be that the cheap mortgage culture has lulled home buyers into a false sense of security by making new borrowings seem especially affordable. The problem, of course, is that mortgage borrowing effectively gears the borrower’s liabilities – a 2% rise in the mortgage rate would send the repayments on a typical £120,000 mortgage up by £200 a month, and a 4% rise would create substantial difficulties for many.

Look Beyond the Headline Figures

All very frightening. But, in fairness, we ought to point out that almost half of the £19.7 billion growth of non-mortgage debt in 2014 came from student borrowing, and not from plastic at all. Student loans are of course guaranteed by the government, and interest rates are capped, and in any case they don’t start to be repayable until a certain level of income has been reached. But PwC reckons that students who started university after 2012 may well end up graduating with average debts of £40,000 to £50,000. Sobering indeed.

About £4.2 billion of last year’s increase came from credit cards, PwC says, taking the average balance on a card to £1,021 – only a little short of its all-time high of £1,060 at the start of 2010.

Another £6.4 billion of new debt came from personal loans and overdrafts and other sources – including payday loans and peer-to-peer loans. The latter, at least, are unlikely to cost as much as bank loans and are effectively capped at the interest rates agreed when they were first taken out. Demand for payday loans is now dropping.

Wanted – A Stress Test for Human Beings

Part of what worries PwC is that UK consumers seem to be blithely confident about the likely impact of this increased borrowing. Only 18% of the respondents said that they were worried about their ability to repay their debts – which may, of course, be a good sign for economic confidence! – compared with 26% in 2013 and 31% in 2010.

A more telling statistic, perhaps, is that fully 12% told the researchers that they of use credit to pay for essentials such as food or bills  – although a sizeable proportion presumably clear their balances every month. Less reassuringly, the proportion rises to 20% among the 35-44 year age group, which is famously getting squeezed harder by household bills than many others.

How good are consumers at estimating the likely repayment cost of a loan? PwC says that four out of five failed to estimate the cost of a mortgage, and just 3% had a realistic idea of what a payday loan might cost them.

UK unsecured debt

(Source: PwC)

Implications for Lenders

It all seems to add up to a rosy scenario for credit card companies, which PwC says raised their ‘spread’ (i.e. gross profit margins) to 17% in 2014, compared with 16% in 2009 and just 10% in 2002.

But PwC warns that these easy pickings are now being eroded by tougher competition, by interest rate caps, by new forms of borrowing, and by a growing trend among younger consumers to use non-credit-card methods of payment. And although bad debts have now fallen to around 3%, from 10% in 2010, the report warns that the underlying trend may soon start climbing again, especially if bank rates rise.

Getting Over The Mid-Life Crisis?

Well, that’s a colourful way of putting it, but PwC says the credit card industry is now looking at a turn in its fortunes. The recent stagnation in the UK credit card market, it says, had only partly reflected consumers’ lack of appetite for debt: it had also prompted suggestions that the long-established product might be suffering something of a midlife crisis as it lost its appeal to younger borrowers, and as it faced significant disruption from new entrants and digital innovation.

There’s no doubting the last part, certainly – today’s consumers have vastly more choice. But in practice PwC says that the credit card product has proven to be resilient, while new entrants have been slower to break through than many expected.

On the whole, and despite everything, PwC refuses to be downhearted by the current trend. There are positives in the solid economic growth of 2.6% (2014 GDP), it says, and in an umemployment rate that’s dropped below 6% for the first time since 2008. Rising real wages have been another positive, even though this is at least partly due to rock-bottom inflation rates that may well turn negative this summer.

But none of it really adds up to a medium-term disaster in waiting, as far as we can see. Just as long as younger borrowers in particular can be persuaded that interest rates, like the value of their investments, can go up as well as down. And that’s where you, Dear Reader, can play your part.

 

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