Budget 2016: ‘Help to Save’? Try tackling personal debt
In today’s budget statement, the Chancellor emphasised the fundamental problem facing young people in the UK: the inability to save, plan for the future, or invest in a pension.
Announcements today included raising the personal tax free allowance to £11,500 each year, and introducing the ‘Lifetime ISA’ for all under-40s from 2017. This is in addition to ‘Help to Save’, a government scheme announced on Monday, designed to incentivise 3.5 million people on low incomes to save £50 a month for four years with a bonus of up to £1,200.
It’s true that savings are in decline but it’s unlikely that a bonus will be enough to change this trend. Incomes continue to be squeezed, the welfare state is being cut, and many are turning to credit to cover the shortfall.
The current UK interest rate is a record low 0.5%, meaning borrowing money is relatively cheap. But if interest rates rise to just 1.75% between now and 2020 a million more households would find their current debts unaffordable and default.
Such forecasts, which could see a total of 5 million households in defaulton consumer debts such as credit cards, bank loans and overdrafts, are concerning those tracking the expansion in unsecured borrowing, which is rising at the fastest rate in a decade.
FIGURE 1: PROJECTED NUMBER OF HOUSEHOLDS IN DEFAULT (MILLIONS)Source: Arrow Global loan default model
But defaults aren’t the only issue here. Households that continue to repay debts also cause problems for themselves and the wider economy.
Bad for the households…
3.2 million households – that’s 12% of all UK households affecting 7.6 million people – spend more than a quarter of their income on paying back their consumer debts, according to forthcoming research from the Centre for Responsible Credit. 1.6 million spend more than 40% of their income on debts.
This is unsurprisingly making it difficult for people to save – a problem that is not going to be solved by the Help to Save scheme, which seems tokenistic compared to the scale of the debt problem.
… and bad for the economy
Defaulting on your debt may sound like the worse possible outcome – a last resort. But for the economy as a whole, households that spend a high proportion of their income repaying debts are just as problematic.
While defaults destabilise financial institutions and could result in another credit squeeze, if too many households are forced to spend lots of their income on debt repayments – rather than on goods and services – the economy will slow.
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One way or another, high household debt will eventually weaken and undermine the economy – whether through Japanese-style stagnation, or another 2008 US-style melt-down.
Which is worse?
For lenders, defaults are worse. Credit card lenders typically offer those who have missed payments various routes out of the debt because defaulting customers are extremely unprofitable – unlike those with persistent levels of debt who repeatedly make only minimum payments on their credit cards.
For borrowers, continuing to pay back debts at a high proportion of income may actually be worse. The strain on household budgets can lead to new debts – getting behind on bills such as gas, electricity, water and council taxbeing among the most common, but which are not included in official debt statistics. Paying back debts also does not ensure you are paying them down. 1.6 million people are repeatedly making only minimum payments on their credit cards. As minimum payments mainly cover the costs of interest, very little of the original debt is being paid off. As a result, most will take decades to clear their debts.
The government’s assumption that such households could save if only they were incentivised to do so ignores the monthly juggling act that many perform between essential spending, rent, bills and debts when surviving on low pay. Attempts to boost savings will only succeed if households are freed from never-ending debt repayment.
So what can we do?
There are multiple psychological and financial benefits in paying off our debts. But at a certain point it is no longer empowering to pay. Debts tie us to our pasts and prevent us from investing in and saving for our futures, as academics from the Political Economy Research Centre argue.
As individuals buckle under psychological and budget pressure, this adds up to a permanent drag on the economy. We’re not arguing for an outright strike on all consumer debt repayments, but there are some debts that should not be repaid at all costs.
If we want to avoid default on unpayable debts and the crushing burden on low income households of never-ending debt repayment, we need give serious consideration to collective debt write-off and address the debt safety net problem which is causing consumer debts to rise. What the Chancellor has promised today will do nothing to address the real reasons that Britain isn’t saving.