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Last Updated: Friday, 29 December 2006, 00:05 GMT
New year could see debt 'tipping point'
By Julian Knight
Personal finance reporter, BBC News

A purse
Money could get very tight for some in 2007

The coming year could see hundreds of thousands of UK consumers suffering a debt "tipping point", a leading debt campaigning charity has told the BBC.

Damon Gibbons, chair of campaign group Debt on our Doorstep, says that just relatively small increases in interest rates - within the range of some economist's forecasts - could spell financial doom for many.

And this, in Mr Gibbons words, could create a damaging "snowball effect" for the whole economy.

"People struggling with their debt repayments put their properties up for sale," he said. "This in turn increases supply and reduces house prices.

"This has a snowball effect - falling prices leads to people who have borrowed against the increased value of their property or buy-to-let investors heading for the exit.

"In turn lenders who have overcommitted, rush to repossess as soon as people get behind with their mortgage re-payments."

But the Bank of England, which sets UK interest rates, sees debt levels as an amber rather than red light scenario.

One of the most striking statistics to emerge from the past few years is that the rise in house prices has been more than swallowed up by fresh borrowing
Damon Gibbons, Debt on our Doorstep

"The banks has warned on debt but it considers it to be more of a personal tragedy for those involved than having serious wider economic consequences," Howard Archer, UK economist at Global Insight, told BBC News.

In other words, the bank sees a rising tide of repossession and bankruptcy as unfortunate but not a "tipping point".

"It is true, though, that due to over-indebtedness more people will feel the effects if rates just rise a little bit than would have been the case in the past," Mr Archer adds.

Debt mountain

Whether or not you believe in the picture Mr Gibbons paints - which he admits is by no means a nailed-on certainty - it has all happened before: in the early 1990s.

The hundreds of thousands of Britons who had their homes repossessed back then will need no reminding of the financial and emotional fallout.

But the UK debt mountain is far, far higher today than it was back then.

In total, Britons owe 1.3 trillion - a mind-boggling figure, equivalent to the national product of all but a handful of countries. About 80% of this is mortgage debt, and the remainder owed on in loans and credit cards.

Still, times have been good. Unemployment and interest rates are low, while house prices have doubled in six years.

People have relied on rising house prices to provide foundations for their finances.

Swallowed up

But many Britons may have got their sums wrong.

"One of the most striking statistics to emerge from the past few years is that the rise in house prices has been more than swallowed up by fresh borrowing such as remortgaging and consolidation loans," Mr Gibbons says.

According to the Halifax, Britain's biggest mortgage lender, a rate rise of just 1% - at the top end of most economists' forecasts for the current rate cycle - would see monthly repayments on a 150,000 mortgage rise by nearly 100.

And this is just the tip of the iceberg, given the second mortgages that many people have on their property.

In recent times I have been encouraged... shoppers are tightening their belts and lenders are no longer subsidising cheap loans and credit cards with fees
Malcolm Hurlston, Consumer Credit Counselling Service

Regardless of the fact that more people fix their mortgage rate than ever before, ultimately higher interest rates can only mean one thing - family and individual budgets squeezed.

And many Britons seem to have sensed that they may be over-exposed to any economic downturn, and are taking some action to reduce their borrowings.

According to the Bank of England, the rate of new borrowing on credit cards and through personal loans has slowed markedly during 2006.

In fact, in some months cardholders have actually been making net repayment on their cards: financial rectitude unheard of for more than a decade.

According to Malcolm Hurlston, chief executive of the Consumer Credit Counselling Service (CCCS), this is part of a pattern of consumers adopting - just in time - a more cautious approach to debt.

"When all the borrowing was going on a couple of years ago I worried how all this would end," he said.

"In recent times I have been encouraged: shoppers are tightening their belts and lenders are no longer subsidising cheap loans and credit cards with fees.

"We are seeing a more level-headed market."

In short, the demand and supply impetus to the credit merry-go-round, which roared into life in the mid-1990s, is finally subsiding.

However, in the big scheme of things, with first-time buyers maxing-out to buy property and remortgaging still running at historically high levels, paying a few hundred pounds off a credit card is neither here nor there.

National Debtline: A free, confidential and independent service funded by the Department of Trade and Industry and the credit industry. Tel: 0808 808 4000
Business Debtline: Provides a free telephone debt counselling service for self-employed and small businesses, partly funded by banks. Tel: 0800 197 6026
Consumer Credit Counselling Service: Funded entirely by the credit industry, the service offers advice to people in debt. Tel: 0800 138 1111
Citizens Advice: Offers free, independent and confidential advice from more than 700 locations throughout the UK. Tel: 0207 833 2181

Long-term problems

Even if crunch time does not arrive in 2007, UK consumers are set to count the cost of the 2000s credit splurge for many years to come.

Low inflation, normally an economic panacea, plays a part in this.

"Just about the only good thing about inflation is that it reduces debt quickly," Mr Archer says.

High levels of debt combined with low inflation, is far from an ideal economic cocktail.

Think about it. If a tipping point occurs and the credit bubble goes pop, economic growth falls or goes into reverse.

In a word: recession.

And with recession inflation usually slumps, therefore it takes even longer for debt to erode.

This is a recipe for long-term economic torpor.

"A couple of decades ago, inflation eroded debt in no time at all. A bit of inflation was therefore a good thing, from a debt point of view," Mr Hurlston says.

"This time we are in for a long haul. But with recent developments I am encouraged about avoiding a credit crash this year."

Trap doors

For those people that face a debt struggle in 2007 and beyond, the prospects are not good.

"What can happen is that people who start to get into debt difficulty rapidly fall through several trap doors," Mr Gibbons warns.

"They start off with mainstream lenders charging High Street rates of interest but as their credit problems get worse the move onto sub-prime lenders who charge higher rates and fees.

"Ultimately, they can end up turning to loan sharks and unregulated money lenders."



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