Hangover Cure: Dealing with the household debt overhang as interest rates rise

Published on Housing, Wealth and Debt

The UK is entering a period in which interest rates are expected to start rising again – with the first moves potentially coming later this year – having insufficiently dealt with the debt overhang. This leaves the UK economy vulnerable to even modest increases in interest rates.

Deconstructing the debt overhang will not be costless, but it is in everyone’s interests – borrowers, lenders, government and taxpayers alike – to adopt a pro-active measured approach rather than simply allowing it to collapse. We favour an orderly and managed dismantling of the debt overhang.

Our modelling suggests that even a relatively benign unwinding of today’s emergency interest rate position allied with anticipated growth in household incomes has the potential to roughly double the number of households facing some form of repayment problem by 2018:

  • The number of ‘highly geared’ mortgagors (spending more than one-third of their after-tax income on repayments) increases from 1.1 million to 2.3 million, equivalent to one-in-four households with a mortgage.
  • The number of households in the more severe situation of ‘debt peril’ (spending more than one-half of their after-tax income on all forms of debt repayments) increases from 0.6 million to 1.1 million.
  • Concerns about the debt overhang are intrinsically distributional: exposure to rate rises is relatively concentrated among low to middle income households. Three out of every four mortgagors in the bottom 10 per cent of the income distribution are found to be ‘highly geared,’ falling across the distribution to just one-in-eight within the top decile. Failing an economic recovery that delivers broad-based income growth across the distribution, today’s debt overhang has implications for future economic and social outcomes.

We favour an orderly and managed dismantling of the debt overhang that covers three broad, and complimentary, courses of action:

  • Maintain the window of opportunity, by resisting significant increases in interest rates until there is clear evidence of sustainable, broad-based recovery, not just in output but in household incomes too.
  • Prepare for the imminent closing of this window, by being more proactive in ensuring that households can and do make appropriate re-financing decisions in order to lock-in today’s low rates for a defined future period.
  • Support those households that find themselves in debt crisis, by ensuring there is sufficient capacity among debt advisers and improving mechanisms for minimising the social and economic upheaval associated with exits from the housing market.