Consumer debt defaults will increase by 17% over the next five years according to Arrow Global, which has published the results of an ‘econometric’ forecast of consumer debt defaults.
The firm says its forecast correlates the default triggers of unemployment and interest rates to existing government predictions of consumer debt levels.
The consumer debt burden has reduced over the last seven years, with government data showing a fall in the debt to income ratio from 145% in 2008 to 120% by H2 2015. However, a cyclical rise in consumer debt is now underway as the economic recovery matures, underpinned by growing consumer confidence and strengthening financial institutions.
The government’s Office for Budget Responsibility (OBR) forecasts a £640 billion increase in consumer debt by 2020, a rise of 37% and an extra £24,000 for every household. Unsecured credit is expected to be the fastest growing component, increasing by 49% (£8,000 per household) by the end of 2020. At that point, net consumer lending will be running at a record level of £142 billion and the consumer debt to income ratio will exceed 160%.
New econometric analysis by Arrow Global of the key drivers of default (interest rates and unemployment) with the OBR forecasts for consumer debt, interest rates and unemployment, projects a rise in debt defaults of 17% between the first half of 2015 and 2020 respectively. This rises to 20% from the expected lows in defaults in the first half of 2016. As a result, the number of households in default on their payments is expected to rise from 4.0 million in H2 2015 to 4.7 million in H2 2020.
Arrow Global says its forecast reflects the normal cycle in defaults. This tends to follow the economic cycle with a lag, with defaults rising once consumers have had the confidence to take on more debt and lenders have had the confidence to increase lending and broaden the range of consumers they will lend to. Arrow Global has also examined the impact of interest rates rising faster than the OBR prediction. Its analysis reveals that if the Bank Rate is 0.5% higher over the whole forecast period, defaults would rise by 24% between the first half of 2015 and 2020, with the number of households in default reaching 5.0 million by 2020. Alternatively, if the Bank Rate rises 0.5% lower than predicted, the number of households in default will rise by only 10% to 4.4 million.
Analysis by Arrow Global of its management information reveals that the typical amount owed by its customers who have previously defaulted is relatively modest and is very stable at around £2,500. This suggests that while the volume of consumers in default may be set to increase over the next five years, this does not mean that the value of a typical default will rise in the same way, it said.
Arrow Global’s analysis also reveals the impact of rising consumer debt and higher interest rates on mortgage possessions and personal insolvencies. These two measures reflect the impact that debt defaulters could face if they fail to make good their debts. Arrow Global’s analysis predicts mortgage possessions to increase by 9% from a low of 10,400 in 2016 to 11,300 in 2020 (a rise of 900) and personal insolvencies to rise by 3% between the low of 78,100 in 2016 and an annualised total of 80,200 in the second half of 2020 – a rise of 2,100 annualised. Although these series remain below their previous peaks, this will be the first sustained increase in eight years.
Tom Drury, CEO of Arrow Global, said: “Low interest rates and reduced lending have led to a fall in the consumer debt burden since the financial crisis. However, the recent upturn in consumer confidence means this trend is ending as overall lending increases and as interest rates rise, defaults will start to increase from their current low levels.
“The rise in the number of individuals in default will make professional debt management all the more important for both lenders and the borrowers in difficulty. The consumer debt industry needs to work closely with advisory consumer bodies now to plan for this rise, so borrowers in difficulty are given the best advice and help in managing their finances.”
The forecast rise in the level of debt defaults follows a seven-year period in which the debt burden has fallen. Although the overall level of consumer debt in the UK rose to a record £1.44 trillion at the end of June 2015, the debt to household income ratio is down to 120% from its peak of 145% in 2008. Total interest payments also fell from 9.3% of disposable income in 2008 to just 4.8% in 2014. Arrow Global analysis of the data reveals that lower interest rates have cut the consumer interest bill by £34 billion between 2008 and 2014, from £90 billion to £56 billion, saving the average household £1,300 a year through this period.
Government data (Department of Business, Innovation and Skills (BIS) shows that 85% of consumers have met all their debt and bill paying commitments, suggesting the vast majority of consumers use debt responsibly. Furthermore indications of stress have reduced significantly since the financial crisis. BIS data shows that individual insolvencies fell by 48% between their peak in Q4 2009 and Q2 2015. Mortgage arrears fell 46% between 2009 and 2014. Debt write-offs by banks and other lenders have also fallen sharply.