What household debt means for the UK economy

Chancellor Gordon Brown certainly doesn't believe debt is something to be ashamed of. In fact he's positively proud about the UK Government's borrowing in his pre-Budget statement, predicting it will be £35 billion in the year to April 2005.

In his 2002 Budget the Chancellor was predicting borrowing would be £13 billion so even he is prone to a bit of over-spending. And yet UK household debt at more than £1 trillion – that is £1,000,000,000,000 if you want to know the number of zeros – dwarves even Mr Brown's pre-election spending spree. It is a big and scary figure which adds up to around £17,000 of debt for every man, woman and child in the UK. Put like that, it sounds even worse. How would you find a quick £17,000 – plus another £51,000 if you have three other family members – if you had to pay it back?

Debt rescue

Luckily it's not that simple - or serious - but household debt is still significant. Figures from Nationwide Building Society show total debt is now at a record 2.75 times disposable income compared with the previous record of two times income hit in the early 1990s. Those with long memories and bitter experience will recall the 1990s boom turned into a spectacular bust. So can it happen again? The answer unfortunately is that nobody knows for certain, but that a rerun of the 1990s is not a foregone conclusion by any means. There are important differences. Interest rates have been raised five times in a row but are still relatively low. A record 28.3 million people are in jobs – an increase of 1.3 million since the start of 1999.

Typical initial mortgage payments currently take 28% of take-home pay compared with 39% in the early 1990s. And of course household debt is not just credit cards, personal loans and overdrafts. Crucially around 82% of total debt is secured on houses. That won't be much help if house prices crash but it is some comfort as it's house prices and mortgages that are significant to the economy while credit card debts and loans are less important. Bank of England Monetary Policy Committee Stephen Nickell in a recent speech pointed out the proportion of income spent by households since 1998 has remained stable. Over the same period the combination of personal debt and mortgage equity withdrawals has soared from 2% of post-tax income to 10%.

Borrow now - pay later

It doesn't at first seem to make much sense but then we've all become much wealthier (thanks to booming house prices) and can afford to borrow more. The surge in house prices though has meant they are now at a record level compared with earnings as first-time buyers can all too painfully testify. And it means house prices and earnings have to get back into line which entails a drop in prices. If or when that happens growth in the economy will slow.

The Monetary Policy Committee has started the slowdown in the housing market by raising interest rates. Figures from various sources and research on house prices show the market is slowing. Mortgage lending has dropped and even credit card and personal loan borrowing has slowed. The British Bankers' Association David Dooks says: 'A slower housing market and tighter household budgets are impacting on consumers' appetite for borrowing.' The appetite though has real need behind it as research for Bradford & Bingley by YouGov shows. It found around 30% of people say their salary is not enough to live on. Borrowing is essential. Just one in five of the population does not over spend each month. Credit cards are seen as the first resort to tide people over, followed by overdrafts.

Your economy needs you

With the best credit cards cheaper than the average overdraft that is perfectly reasonable behaviour as long as you can afford to meet your payments. And of course it is almost your patriotic duty to spend, as your economy needs you. The reasons Chancellor Brown is so confident about getting the country into debt is that he believes the economy will keep on expanding and rising taxes will enable him to pay off the debt. Other economists are not quite so sure. Stockbrokers Gerrard point out the production industries are slowing although construction and service industries are booming.