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11.07.2017

Is the UK in a debt trap?

Phillip Hammond, the UK Chancellor of the Exchequer, recently made a remarkable confession whilst addressing a dinner held by the Confederation of British Industry.

He admitted that after 7 years of austerity, the sunny uplands of the UK economy, were still out of reach of many UK consumers; or as he put it, frustratingly one ridge away (but as anyone who has been hill climbing knows, even when you get to that ridge, there is usually another waiting for you).

In a recent blog, Creditfix looked at this issue by interviewing, nurse, Lorinda Clark, who spoke of how devastating debt has been on her life and how it had been exacerbated by the public sector pay cap.

The truth is for many British consumers, this financial Eden of sunny uplands may as well be fictional. It is today more elusive than it was in 2010 when the UK Government embarked on its’ policy of austerity.  There are now over 5 million UK public sector employees who have been living with a 1% pay cap ever since 2010, which when you consider inflation, has meant a 14% cut in real terms.

The result of this is, where the UK Government has emphasised the importance of financial discipline to cut the national deficit, the cost of growing the UK economy has fallen on British consumers, many of whom have been relying on credit cards, personal loans, and personal car finance plans to get by.

It should come as no surprise then, that all the evidence suggests, unless something changes, personal debts in the UK will continue to increase, with the Office of Budgetary Responsibility (OBR) predicting that by the end of the decade we will be spending £68 billion more each year than we earn. The UK Government may be trying to balance its books, but the harsh truth is UK consumers are increasingly sinking into debt.

Worryingly, there is now evidence to suggest that this increase in personal borrowing will not be sustainable, with the Bank of England concerned about the level of personal debt.  Only two weeks ago, Mark Carney, the Governor of the Bank of England ordered financial institutions to put more funds aside to protect against bad loans, warning them they were at risk of forgetting the lessons of the last credit crunch. This inevitably, will not only restrict the funds available to financial institutions, but will also send a message to them: the more they lend, the more funds they will have to put aside to cover bad lending.

None of which paints a reassuring picture. If people going forward find it harder to borrow, they ultimately will have less money to spend. For some, this may precipitate a debt crisis, particularly where borrowing money is making up the shortfall in their household expenditures.

It also suggests that if the economic strategy for growing the British economy is not one that will be funded by public expenditure, then it’s unlikely increased consumer expenditure, funded by personal debt, will prove to be a sustainable, long term strategy.

The Magical Money Tree

The emerging picture is of a Britain now caught in a debt trap. If we want to see the economy grow, there needs to be more spending. However, as we heard during the General Election, there is no magic money tree, so hard decisions will need to be made as to who pays the cost of that spending.

If it is to be funded by private household spending, then it is likely it will have to be funded by a money tree of long-term, unsustainable debt. This poses substantial risks to the public purse, as we saw the last time the banks failed.

If it is to be funded by increased public expenditure, then the medium-term prospects are that the UK Government will struggle to reduce the national debt or cut the UK deficit. Taxes are, therefore, likely to increase.

Inevitably, all this points towards households experiencing financial distress for years to come, which if other factors begin to occur and converge at the same time, could create a perfect storm: interest rates rising (which it is expected could begin later this year) and unemployment increasing, with firms relocating outside the UK and cutting investment because of Brexit.

Weathering the Storm

So, if things do go bad, how do people survive?   The message must be to repair the roof when the sun is shining. The problem is the sun is not shining, but if things are only likely to get worse, then this is the time to begin to patch up the holes.

Financial Planning

First getting a grip of your financials is essential. There are competing economic theories about whether it is important or not, in a time of crisis, for Governments to balance their books, but for households, it is essential. Unlike Governments, who can increase taxes when they need to, households can rarely just give themselves a pay rise.

Second, pay down your debts if possible. This may mean curtailing your expenditure and budgeting, but in the long term if that allows you to avoid personal insolvency later, it is a burden worth bearing.

Third, don’t rely on things you cannot control. None of us know exactly when we may get a promotion or a pay rise, so don’t depend on them. Always plan for the worst-case scenario. Equally, we don’t know when the Bank of England base rate of interest will increase, but all the indications are it could happen by the end of this year.  It is currently just 0.25%, but it’s worth remembering that for at least half of the last 40 years its was close to or higher than 10%; and in 1979 was as high as 17%. More recently in 1989 it was as high as 14.87%.

Even a 3% increase on a £150,000 mortgage, taken over 25 years, and currently with an interest rate of 3%, could see monthly payments increase by £255 per month. It may be a good time to consider, for the sake of financial stability, whether a 2-5-year fixed interest rate would be in your best interests.

Finally, if you are unable to pay your debts as they fall due, or you can only pay the minimum payments each month, it’s time to seek professional debt advice. Rarely will an unsustainable situation become sustainable by ignoring it.

If you need more information about the options available to you in dealing with your debt, you can always speak confidentially with one of our friendly advisors on 0808 2085 198.