Are UK Families at risk from the Two-Income Debt Trap?
18th April 2017
Could welfare reforms for those in work increase the risk that more families will now fall into the two-Income Debt Trap?
What is the Two-Income Debt Trap?
The Two-Income Debt Trap was first identified by US Senator, Elizabeth Warren, in 2003 when she was a law professor at Harvard University. She identified that increasingly America’s middle classes could no longer survive on just one income.
She found not only were they collapsing under the weight of the cost of living, but one of the biggest indicators that a woman would go bankrupt was whether she had children or not; she also found more children were living through their parent’s bankruptcies than were living through their divorces.
America’s middles classes were struggling to pay four main bills each month: health care, their mortgages, child care and car payments.
Her research also found that as a proportion of household income, spending on food, household gadgets and clothing had dropped in real terms since 1970; challenging the perception that the 500% increase in bankruptcies that America saw between 1980 and the beginning of the millennium was driven by over spending on unnecessary consumer goods.
Families also experienced a stripping away of two key buffers in their household: the first of these was the percentage of their monthly income which they had spare; and the second, the amount of savings they had in reserves. This meant they were susceptible to even the slightest of income shocks.
These income shocks, she found, didn’t mean bankruptcy happened immediately, but was often the precursor, not to families being refused credit, but being targeted for unaffordable credit.
The effects, she found, crept up slowly but gathered speed quickly before bringing matters to a head, which for many meant bankruptcy.
The Two-Income Debt Trap in the UK
In the UK, many are now been caught in the Two-Income Debt Trap, albeit the household bills that weigh heaviest in the UK differ from those in the United States.
The amount spent on health care is not as much and for many years many families received support with childcare; however, as benefits, like tax credits, have suffered cuts, not only has the need for two incomes increased, but the level of income required has risen.
This can be seen from a report that was produced by the Joseph Rowntree Foundation in 2014. That found families with two children required an annual income of £40,600 to have an acceptable standard of living. An increase of 50% on what was required prior to the recession, primarily due to benefit cuts and soaring fuel bills. This applied also to loan parents, of which 90% are women. The report found they required an income of £27,000, up from £12,000 in 2008.
More recently a report carried out by the Money Advice Service in 2015 found that as many as 40% of all UK adults had less than £500 in savings, suggesting many lacked the buffer of having some disposable income to allow them to save.
What can you do to avoid the Two-Income Debt Trap?
If you are at the beginning of starting a family, the first thing to do is anticipate that your household costs will increase. The Centre for Economics and Business Research has recently estimated raising a child to the age of 21 can cost up to quarter of a million pounds. There is no point therefore, in starting your new life burdened with debts, as the likelihoods are you will get plenty of opportunity to acquire these later.
You also must anticipate that it may not always be possible to have two incomes: pregnancy, illness and unemployment often interrupt a family’s income. Raising a family is a marathon, not a sprint.
Prudently you must build in buffers where you can, whether that’s in deciding what type of wedding you have, what kind of house you buy or what car you purchase. It’s important to get a grip on your finances as early as possible.
Where you already have a family, and have found you are in the Two-Income Debt Trap, it is necessary to begin pruning away the excess fat where you can, by shopping around for different utility and other service providers. If you are lucky your income may increase as your career progresses, but you cannot rely on that, particularly in today’s world where technology is revolutionising industries and making many roles redundant. The goal must be to create enough breathing space in your finances to begin saving.
The Jam Jar Approach to Household Finances
We can also learn a lot from our parents and grandparents. In the past, good financial housekeeping skills were passed down from parents to children. These must be relearned. Sometimes described as the jam jar approach to household finance, this involved dividing household income up and placing different amounts in different jars for different purposes. Today new technology and smart phone banking apps can help us do this more easily. They can even tell us what we are spending, how we are spending and where we are spending.
We also now need to be more objective as consumers. The prudent consumer of today is a sophisticated consumer who has financially educated themselves. The bank manager no longer knows what’s best. This can be seen with mortgages, which in the past were the gold standard of credit checks: banks wouldn’t lend unless they were convinced you could afford it and you had buffers built into your household expenditure. Now lenders often lend because it’s in their best interest, not yours. The gold standard no longer exists.
This means you need to become a more effective financial planner. Your first home doesn’t need to be your dream home. That can come later. You don’t need to constantly be upgrading your gadgets, and there is no shame in deciding to address those difficult debts now before they become unmanageable: a few years of difficulty are better than a lifetime of struggle.
The key is to build in buffers. Buffers in your day to day spending by ensuring you have money left over and buffers to make sure you have some savings. As the old maxim goes, when the sun is shining, repair the roof, so you need to make the sun shine to buffer yourself and your family from the Two-Income Debt Trap.