How severe is the consumer credit debt burden?

The latest figures from the Bank of England indicate that the stock of consumer credit debt (excluding Buy Now Pay Later) has reached an all-time high of £232 billion (figure 1, below).¹

Figure 1: Total Consumer Credit (£ billions), 1990 to 2024

These figures do not include Buy Now Pay Later ('BNPL'). As this sector is currently unregulated, BNPL lenders do not have to report their outstanding balances and are not included in official statistics. Nevertheless, economists at the Bank - using household survey data from 2023 - estimate² BNPL adds a further £2.7 billion (1.2%) to the total.

Despite this expansion, the ratio of consumer credit debt to aggregate gross income has been falling. In February this year, the Resolution Foundation (2024, p.7)³ noted:

"…while consumer debt has grown in the past couple of years, it hasn’t kept pace with growth in household incomes. Real wages have been flat…but nominal wages are growing quickly as workers seek to maintain their purchasing power in the face of high inflation… this has caused consumer debt as a share of household income to fall to a historic low of 13.2 per cent in September 2023.” (our emphasis).

This statement is not quite correct. Whilst the ratio of consumer debt to household income has fallen since the pandemic, it is not at a historic low. It has, however, returned to a level last seen in 1997 (figure 2, below).

Figure 2: Aggregate household consumer credit to gross income ratio⁴

At first sight, this seems very positive. A falling credit to income burden should mean that fewer households are struggling to pay their debts. However, several questions arise, which this blog attempts to answer:

·      How should we judge an aggregate ratio of 13.2% in historic terms?

·      What is the distribution of consumer credit debt-to-income ratios within the population?

·      What is the distribution of debt servicing ratios within the population?

·      Can the debt-to-income and debt servicing ratios be combined to provide an indication of the overall severity of the debt burdens that households are experiencing?

·     How can we take account of the expenditure pressures that households have experienced during the cost-of-living crisis?

The aggregate ratio

The current aggregate ratio is certainly much lower than its peak of 23% in 2005/06 (the year prior to the start of the Financial Crisis). But the period from 1997 to 2006 was characterised by an extraordinary expansion of consumer credit relative to incomes and was associated with widespread irresponsible lending practices.⁵

The divergence of consumer credit from income is highlighted in figure 3, below. This plots the indices of consumer credit and gross incomes using the second quarter of 1997 – when Tony Blair entered Downing Street as Prime Minister for the first time – as their base.

Figure 3: Indices of consumer credit and household incomes, 1997q2 =100

Whilst both aggregate consumer credit and household incomes have nearly tripled in nominal terms since the middle of 1997, consumer credit has been on a wild ride over the period.

Consumer credit  grew much faster than incomes through to the financial crisis; fell broadly back in line between 2012 and 2016, but then significantly departed from it again through to the start of the pandemic. The pandemic provided a sharp correction, and since 2021 consumer credit has grown broadly in line with incomes. It is only marginally below that trend today.

This return to the pre 1997 norm – when the consumer credit growth rate was slightly lower than the growth in incomes - is welcome. But rather than thinking of the current ratio as low in historic terms, we should consider the aggregate debt-to-income ratio for most of the past twenty or so years as having been abnormally high.

It should also be noted that the aggregate measure doesn’t accurately describe the consumer credit debt burden as it is experienced for those holding such debts. Survey data (see below) indicates that around one third of households don't have any consumer credit debt at all.⁶ Dividing total consumer credit by the aggregate of all household incomes makes little sense when this many households don’t have any debts to pay.

What we should be concerned with is the proportion of debt relative to the incomes of those who actually hold it (their ‘debt-to-income’- ‘DTI’ - ratios); how much those households are paying towards those debts (their ‘debt servicing to income’ - ‘DSR’ - ratios), and how these vary across  the income distribution. Aggregate data cannot answer these questions. We are therefore reliant on household surveys to do so.

Analysis of the NMG household debt survey

The most recent data comes from a household debt survey commissioned by the Bank of England and conducted on its behalf by NMG Consulting (‘the NMG survey’). This contains around 6,000 responses and is weighted to be nationally representative.

The 2023 survey contains details of household incomes; types of consumer credit held, outstanding amounts, and the last monthly repayments that have been made. We therefore undertook an analysis of these variables to estimate the distribution of consumer credit use, and the DTI and DSR ratios.

We then created a composite 'severity' score, representing both the cost of servicing debt and the estimated durations that households will take to repay it.

Finally, we combined the survey data with information previously published by the Bank concerning the proportions of gross income that households in each income decile are spending on essentials. This enabled us to construct cost-of-living adjusted DTI and DSR ratios and severity scores.

Use of consumer credit

There is a statistically significant relationship between household income and the likelihood of having consumer credit debt (figure 4, below).

Figure 4: Likelihood of having consumer credit debt, 95% confidence intervals

Just over half (52%) of households with incomes below £17,500 have consumer credit debts, compared to two-thirds of households with incomes between £17,500 to £54,999, and nearly three-quarters with incomes over £60,000.

The poorest households also hold slightly different types of debt. They are about half as likely (7.6%) to hold personal loans compared to households with incomes above £60,000 (16%). They are also much less likely to have car finance arranged through a dealership (8% compared to 21%). Around a third use credit cards compared to just over half (52%) of all other households.

However, one in eight of the poorest report having overdraft debt, which is very similar to other households (14%), as is their use of BNPL (~10%).

Debt-to-income ratios

Across all income groups – but only including the incomes of households with consumer credit debts - the mean consumer credit DTI ratio is 22%: significantly higher than the 13.2% provided by the aggregate data.

However, the distribution is more important than the overall average. Whilst the poorest households are less likely to have consumer credit debt, those that do so hold more of it relative to their gross incomes than any other group (figure 5, below).

Figure 5: Distribution of DTI ratios by income group (median marked by circle)⁷

The median DTI ratio for the poorest households is around 8%, compared to 4.5% for those with incomes of £60,000 or more. But around a quarter of the poorest households have DTI ratios over 40%. Hardly any households in the higher income groups have ratios in this territory.

Debt repayments and debt servicing ratios

The typical debt repayments being made by households increase in nominal terms as incomes rise (figure 6, below). For those on the lowest incomes the median is around £200 per month, compared to £500 per month for households with incomes of £60,000 or more.

Figure 6: Monthly credit repayments (£), by income group (median marked by circle)⁸

However, the poorest pay more as a percentage of their monthly gross incomes (figure 7, below).⁹

The overall median DSR - across all income groups - is 10%. But the poorest typically spend twice as much of their monthly incomes on debt repayments, and a quarter are spending more than 60%. Some are spending more than their entire monthly income on repayments, which can only be possible if pre-existing savings are being run down; assets are being sold, or - as seems most likely - households are borrowing more money to make the repayments on existing debts.

The consumer credit debt burden

Assuming monthly repayments remain constant and households neither borrow more nor pay down their debts by selling assets or using savings, the survey data makes it possible to estimate the length of time needed for households to clear their debts. The results, by income group, are set out in figure 8, below.

Figure 8: Estimated duration (months) to clear debt, by income group (circle is median).¹⁰

The median estimates do not vary significantly by income group and are all between 12 and 18 months. But it is notable that a quarter of households with incomes of £60,000 or more will take longer than 40 months to clear their debts. Some in this group will take over eight years. The longer repayment periods for many higher income households reflect the fact that these are more likely to have sizeable personal loans and car finance agreements. Repayments are spread over long periods but are reasonable with respect to income.

However, it is also apparent that a quarter of the poorest households will take more than 36 months to clear their debts at current repayment rates. This suggests many of these are experiencing severe debt burdens, having both high DTI and DSR ratios.

The severity of the consumer debt burden comprises both its intensity (the DSR) and its duration. Whilst households might be expected to cope with high repayments for short periods, they cannot reasonably be expected to do so over many months. The logical consequences are cutting back on essential spending, becoming caught in an increasing debt spiral and, at some point, default.

We therefore calculated composite severity scores for households.¹¹ To illustrate how these relate to their DSRs and expected repayment durations, figure 9, below, provides box plots of the three measures using a normalised scale between 0 (least severe, lowest DSR, shortest duration) and 1 (most severe, highest DSR, longest duration).

Figure 9: Severity, DSR and Duration Scores, by income group (median marked by circle)¹²

The poorest households have the most severe consumer credit debt burdens. They typically experience a combination of higher DSRs and longer repayment durations than other income groups. Their median composite, 'severity', score is 0.2: a third higher than the overall population median of 0.15. But a quarter of the poorest have scores above 0.33 and they extend to over 0.6.  The range is significantly higher than for all other income groups, although it should be noted that they also contain some households with higher-than-average scores.

The cost of living crisis

The analysis above centres on credit balances and monthly repayments in relation to gross household incomes. It therefore fails to capture the impacts of the cost-of-living crisis, which has squeezed disposable incomes in recent years.

We have long argued for measures of the household debt burden to be based on disposable rather than gross incomes, and therefore welcomed the development of ‘Cost-of-Living Adjusted DSRs’ by the Bank of England in its Financial Stability Report of July 2022. These take account of the share of income that households spend on essentials, including household bills, food, transport and communication. According to the Bank¹³:

"The share of income spent on taxes and such essential spending varies greatly across the income distribution – for households in the lowest income decile, it accounts for around 90% of their income, relative to around 45% for households in the highest income decile.”

To date, the Bank's analysis of these adjusted DSRs has primarily focused on households with mortgages. This is because of concerns that increased debt burdens for these could feed through into higher mortgage arrears with potential implications for the stability of the financial system.

Our primary concern is with the burdens experienced by lower income households. As further details of the distribution of essential spending as a percentage of gross incomes for each income decile were made available by the Bank in Chart 1.2 of their report, we adjusted the household incomes reported in the NMG survey to take account of these (figure 10, below).

After accounting for essential spending, half of the poorest households are left with less than £5,000 per year (£416 per month) to live on.

Figure 10: Household income adjusted for essential spending, by gross income group (median marked by circle)

As may be expected, recalculating the DSRs using these adjusted incomes has a dramatic impact for this group (figure 11, below).

Figure 11: Cost-of-living adjusted DSRs, by income group (median marked by circle)

Across all income groups, the median adjusted DSR is around 20% but for the poorest households it is over three times higher, at 66%. Even more shockingly, just under half of the poorest households have cost-of-living adjusted DSRs of 100% or more. And more than a quarter have ratios over 200%.

These extremely high ratios indicate it is impossible for many of the poorest households to meet both their essential costs and their debt repayments. They are faced with an ever present 'choice' of drastically cutting back on essential spending to pay their creditors; somehow borrowing more, or defaulting.¹⁴

The extremely severe nature of their debt burdens compared to other groups is also clearly apparent in their cost-of-living adjusted severity scores (figure 12, below).

Figure 12: Cost of living adjusted severity score, by income group

Following adjustment for essential living costs, the median severity score for the poorest households rises to 0.33. This typical burden is twice as severe as for all other income groups (median = 0.17). A quarter of the poorest experience debt burdens which are at least three times as harsh.

Conclusions

Whilst the aggregate consumer credit debt to gross household income ratio has fallen since the pandemic, this should not be viewed as indicative of a ‘historic’ improvement in the ability of households to pay their debts. It does, however, represent a welcome return to the pre-1997 norm where consumer credit debts grew more slowly than incomes.

The aggregate measure fails to capture how debt burdens are distributed. And, because it is based on the division of consumer credit debts by the aggregate of all household incomes rather than by the incomes of only those households with any debt to pay, it also under-estimates the average burden.

To explore the distribution of the consumer credit debt burden both across and within income groups requires survey data. Our analysis of the Bank of England’s 2003 NMG Survey indicates that the mean consumer credit to gross income burden is 22%.  It also finds:

·      The poorest households are less likely than other income groups to have outstanding consumer credit debts.

·      But those which do have consumer credit debts hold more of it relative to their gross incomes than other groups.

·      The poorest also pay more of their gross incomes on debt repayments than other income groups.

·      The intensity of debt repayments and the duration over which they are required to last means the poorest households experience the most severe debt burdens.

The use of ratios based on gross incomes nevertheless masks an even more shocking reality. After adjusting for essential spending, the poorest households typically have disposable incomes of less than £5,000 per year.

For those with consumer credit debts, their repayments typically take up two-thirds of their disposable incomes - and in many cases exceed all of it. This renders them unable to meet both the cost of essentials and their debt repayments.

The severity of consumer debt burdens are best understood as comprising both the scale of repayments relative to disposable income and the duration over which those repayments will need to be made. The cost-of-living adjusted severity scores indicate that the poorest households experience debt burdens twice as severe for other income groups, and a quarter are experiencing burdens which are at least three times as great. The poorest shoulders are carrying by far the greatest weight.

These households are being forced to make stark choices between eating, heating, and paying essential household bills or paying their creditors. The unavoidable conclusion is that urgent action is needed to reduce the consumer credit debt burdens of households with incomes below £17,500 per year.

Notes

1. Source: Bank of England Series LPQVZRJ (Quarterly amounts outstanding of total sterling net credit card lending to individuals, seasonally adjusted) + Series LPQB4TS (Quarterly amounts outstanding of total -- excluding student loans and credit card lending - sterling net consumer credit lending to individuals, seasonally adjusted).
2. Gunner, G. & Waddell, J. (2023). ‘Shining light on ‘shadow credit’ – what is Buy-Now-Pay-Later and who uses it?’. Bank Underground. Available at https://bankunderground.co.uk/2023/08/23/shining-light-on-shadow-credit-what-is-buy-now-pay-later-and-who-uses-it/‍
3. Odamtten, F., & Pittaway, S. (2024). ‘In too deep? The impact of the cost of living crisis on household debt’. Resolution Foundation. Available at https://www.resolutionfoundation.org/app/uploads/2024/02/In-too-deep.pdf‍
4. CfRC calculations using total consumer credit (see footnote 1) divided by Gross Household Disposable Income – series RPHA from the Office for National Statistics, rolling 4 quarter sums.
5. The extent to which lending had become irresponsible was highlighted by several suicides in 2005 and led to important new consumer protections in the Consumer Credit Act of the following year. These included the requirement to lend responsibly, and the Act also established the Financial Ombudsman Service.
6. CfRC analysis of the 2003 Bank of England Household Debt Survey commissioned from NMG Consulting.
7. N=2,717. Graph excludes outliers.
8. N=764. Graph excludes outliers.
9. N=761. Graph excludes outliers.
10. N=735. Graph excludes outliers.
11. The survey data contains some significant outliers. We therefore removed these prior to normalising the scales for DSRs and expected repayment durations and then combining these into a single score on the same scale.
12. N=655. Graph excludes outliers.
13. Section 1.4.1, Financial Stability Report, July 2022. Available at https://www.bankofengland.co.uk/financial-stability-report/2022/july-2022‍
14. Possible alternatives include selling assets, using pre-existing savings, or borrowing more.

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