An Assessment of the Impact of Mortgage and Non-Mortgage Loans

Toby Clark a senior fiscal analyst in MINTEL comments There is a major need for fiscal education and for a drive to prompt borrowers to take a saucy look at their debts. With unwrap a critical understanding of exactly how much they owe and what set ups they atomic twist 18 stomaching, it is easy to see how the situation could spiral out of control. This statement cl primordial highlights the position of the middling British consumers as far as their owe and non-mortgage debts argon concerned.It is observed by the report from MINTEL that the British consumers who clear bang-up mortgage debts study a better control on the amount of their outstanding than the non-mortgage debt consumers. When the mortgage holders were asked to estimate the amount of the outstanding loan they could estimate the figure at ? 92,200 which matched with the estimation of ? 95,000 shake off by Bank of England and mortgage lenders. There atomic number 18 take cut backent purposes for which the co nsumers obtain mortgage and non-mortgage loans.The purposes besides differ between different income earners. The high income earners borrow for paying a digest, buying a second foot or for paying the university or school fees of their children. Whereas the moo income earners hurt tot anyy different purposes of pickings the loans want bringing up their children paying their tax bills or meeting their regular commitments. Irrespective of the purpose for which the loans are taken the loans do maintain an impact on the financial soundness of the borrowers.On few occasions and for few consumers the loans perish handy to take superintend of their financial make do but in close to of the cases the loans slang had adverse impact only on the lives and finances of the consumers. Especially when the average consumer does non even accomplish the hay the extent of their debts the impact would be still worse. Many debt problems are caused by poor decision making, with victorious o n to a greater extent debt to pay back what debt you already retain non al focusings a apt move, according to the free and impartial debt advice organisation Debt Free Direct. (Linkroll) In most of the cases the consumers get in to debt traps both due to poor decision making or not being accu roamly able to measure the impact the debts cod on their financial capabilities and standing. This includes the decisions of debt consolidation. Quite often consumers think that debt consolidation is the best beginning for solving their debt problems which will only aggravate the warhead to the already debt trapped consumers. The loan burden on the borrowers is arouse to increase by the actions of the lenders too.Luring the customers in tot taking additional loans with the intention of just increase their bestow activities and without assessing the capabilities of the borrowers to pay back the loans often take the borrowers to a point of no return. A number of Britons report that the ir debt problems are causing them difficulties in early(a) areas of their intent, according to a new field of honor. In interrogation carried out by R3 the Association of Business Reco precise Professionals adept out of sextette consumers are verbalise to be unable to misrepresent with quittances on secured loans and credit cards. (Loan Arrangers)With this background I intend to draw off an analytical determine of the British Loan Market and its impact on the average British consumers. In the process I similarly intend to study the kinds of mortgage and non-mortgage loans available to the consumers in the UK. 1. 1 search OBJECTIVES This study has among other things the kindle central objectives 1. perusal the psychological and economicalal reasons for the British consumers getting in to the debt trap. 2. Analytical study of the impact of the several(a) loans on the lives and financial wellbeing of the average consumers including mortgage and non-mortgage loans.3 . Studying the role of the banks and other alter institutions on extending the debt burden of the average British consumer 1. 2 RESEARCH QUESTIONS This study by undertaking a detailed research in the consequence tries to find plausible answers for the following research questions 1. What are the prime reasons that make the British consumers to get into the debt trap? 2. What are the major impacts that the mortgage and non-mortgage loans confuse on the lives of the average British consumers? 3. What are the different ways that an average British consumer piece of tail manage the debts effectively? 1.3 STRUCTURE OF THE DISSERTATION In order to present a comprehensive stem I intend to divide the paper into the different chapters. While chapter 1 introduces the subject matter of the study to the readers along with stating the research objectives and questions, chapter 2 makes a detailed erectvas of the available literature on the subject of the impact of debts on the British cons umer. Chapter 3 makes a detailed presentation of the research methodology espouse by this study for conducting the research. In chapter 4 I have included the findings of the research and a detailed discussion on the analysis of the findings.Concluding remarks recapitulating the issues discussed in the paper and few suggestions which will enable the British consumer to manage his debts are included in the chapter 5. CHAPTER 2 LITERATURE REVIEW CAPM, Bonds, Securities, Economics, Finance This chapter presents a detailed review of the available literature on the debt unveiling by the British consumers and the impact of such debt creation on the bond and securities market, on the finance and monetary policy and economic situation of the country apart from the life styles and financial status of the respective(prenominal) consumers. 2.1 IMPACT OF DEBT beingness ON BOND AND SECURITIES MARKET A up-to-the-minute report from Bloomberg. com says European 10-year bond yields held near a t hree-month low as an Australian hedge livestock filed for bankruptcy protection on losses related to a slump in U. S. home loans, proffer speculation global economic expansion will slow. (Lukanyo Mnyanda, 2007) There has been a widespread skepticism almost the future of the bond market because of the higher(prenominal)(prenominal) levels of failure in the sub prime mortgage repayments. This phenomenon has also been felt in the UK which is unmixed from the statement of the credit rating firm Standard & Poor.Standard & Poors say business conditions for securities firms are worse than in the second half of 1998 when trading revenue slumped 31 portion after Russias debt default. Revenue from investment banking and trading could fall 47 share in the final six months of this year, the ratings company said. (Lukanyo Mnyanda, 2007) 2. 1. 1USE OF OPTIMIZING MODELS IN THE CONTEXT OF CONSUMER DEBT On the basis of micro economic foundations at that place are accepted beats that analy se the likely economic consequences of structural changes in the miserliness.Though in general these models help the analysts to comment upon microeconomic foundations, mosttimes these models are found inappropriate for analyzing such consequences. This is because their parameters are generally complicated functions of an economys technology, institutions and regime policy, and the preferences of economic agents. Subsequent changes in any of these structural characteristics would mean that those parameters, and hence the relationships between samara economic variables, would be expected to change. (Bank of England)However the optimizing models enable the analysis of the deep structural relationship which is considerent upon the individual variables in relation to the economic shocks and their identification. The optimizing models describe the intertemporal optimisation problems facing economic agents. They often try to witch the interactions between the different types of age nt in the economy (consumers, firms, g e rattlingwherenment, unlike sector), each of which is assumed to solve distinct dynamic optimisation problems, subject to certain informational and technological constraints.These models can be used to analyse how economic agents might optimally respond to various demand and supply shocks that have or might hit the economy, or to changes in the structure of the economy. Equally, they can be used to examine likely explanations for observed patterns of deportment in the data. (Bank of England) These models are useful in Modeling consumer behaviour including consumer authoriseing Applications to financial markets Analysis of the force market Analysis of the role of funds One of such models being widely used is the CAPM which can provide useful insights into the reasons behind the financial market changes.However there is a in force(p) limitation of this model is that it does not perform well in the empirical tests. 2. 2 IMPLICATION OF THE RISE ON THE folk DEBT ON THE MONETARY POLICY It is observed that the increase in the firm debt in the UK eachplace the polish three decades was the result of the continued increase in the owner-occupied buildings and the number of mortgages gaind as a remainder of the total households. The rise in the prices till the time of the sub prime mortgage issue was also because of this change magnitude private ownership of the houses.However it is pastimeing to note that the increase in the household debt didnt have much impact on the consumption growth. This was due to the fact that the households were focused on the accumulation of financial assets during the recent past. Finally, while it is possible that higher levels of debt may make household consumption more sensible to pastime rate changes, this may easily be offset simply by moderating these analogous changes. (Stephen Nickell) While there was few contraction in the economies of US and Germany, the UK economy rem ained buckram during the year 2001.There was a significant relaxation in the monetary policies of the country during this catch and hence the UK economy witnessed an increase in the domestic demand though the situation was different with the world economy which was weak and was suffering a fall in investments. The increase in the domestic demand made the overall growth rate of the economy positive. However approximately of the economists were of the view that such a growth in the UK GDP as against the widespread recession in other developed countries was possible only at certain implied costs.For guinea pig in an denomination in The Observer dated 27th marching 2005 Fred Harrison noted that Encouraged by low interest rates, citizenry went on a spending spree. They reduced savings and extracted equity from their homes to raise a consumption boom A similar view was expressed by Hamish McRae in his article in the The Independent stated What is, however, clear is that the credit -fireled spending boom is, one way or another, approach path to an end. (The Independent dated 16th March 2005). Hence it was observed that booming consumption resulted in a rapid expansion of debt.Thus there has been a significant increase in the debt to income ratio which was a matter of austere concern to the analysts and the financial economists. In this context Philip Thornton made the following remark in the The Independent issue dated 30th July 2003 Britons piled on an all-time record amount of debt end month, triggering fears that consumers have embarked on an unsustainable borrowing binge that will end in a crash reminiscent of the early 1990s 2. 2. 1 RELATIONSHIP BETWEEN INCOME, CONSUMPTION AND HOUSEHOLD DEBTSGenerally it is assumed that the macroeconomic policies of the UK government had resulted in a house price bubble coupled with a boom of the consumer spending. Thus the economy got missed out from the impact of the global recessionary trends. However Stephen Nickel l argues that over the period 2000 to 2003 which was supposed to be the consumption boom the average quarterly consumption growth was only 0. 77 percent very similar to the average consumption rate of 0. 72 percent that was existed over the cultivation twenty fiver years.The consumption rate was also downstairs the average consumption rate in the previous period 0f 1996 to 1999. From 1998 to the end of 2003, the proportion of post-tax income that was consumed was relatively flat, hardly evidence of a debt fuelled consumption boom. Nevertheless, mortgage equity insularity (MEW) plus unsecured credit growth rose from around 2% of post-tax household income in 1998 to over 10% in 2003. So there was indeed a significant rise in the rate of household debt accumulation from 1998 to 2003 despite the fact that the ratio of consumption to post-tax income remained stable throughout. (Stephen Nickell) With this argument the author homecoming to state the mass of mortgage equity withdrawal leads to increased financial assets accumulation and not to increased consumption. Further it is also argued that there is a strong relationship between the aggregative secured debt accumulation and aggregate financial asset accumulation especially in a period of rapidly spiraling house prices. Similarly there is no strong relationship between the factors of aggregate consumption growth and debt accumulation. In that case the following will be the effect of the household debt on the monetary policy.2. 2. 2 high LEVELS OF DEBT AND MONETARY POLICY May et al (2004) observed In 1975, household debt was around 38% of household post-tax income. By 2004, this had risen to around 125%. Currently, over four-fifths of household debt is secured on property, ie. consists of mortgages, and around 95% of all household debt is held by mortgagors. As already stated the important factor causing the rise in the household debt was the increase in the number of owner-occupied buildings and the prop ortion of the houses carrying a mortgage.Another factor that contributed the increase in secured debts is the change in the mode of financing by leaving the front end loading of the repayment of mortgages. Such a method of financing has lead to higher loan to income ratios. It also resulted in higher mortgages relative to income. Based on these basic premise there are three arguments that can be support the view that the household debt is a predominant factor in the determination of the monetary policies. 1. The runner argument is based on the concept that the there will be significant impact on the bahaviour of the economy due to shocks if there is a high level of household debts.As observed by Griffiths focusing Debt is a time-bomb which could be triggered by any number of shocks to the economy at any time (The Griffiths Commission, 2005, executive director Summary). Though any adverse economic shock will have the impact on the conflict and the consumption levels, higher level s of debts will make the conditions worse. The excessive debt may still induce greater preventive saving and a larger drop in consumption. Overall, it is hard to tell whether higher debt levels will capture a significant additional cut back in consumption which cannot be modified by easier monetary policy2. The second argument is based on the possibility that the there may be a cut in the consumption due to the sudden realization of the debtors about the real interest on the debts and their extent of exposure to the debts in spite of their efforts to reduce the level of debts. This will create exhausting macro economic problems leading to large scale adjustments in the monetary policies. However this argument is countered by indicating that the inexperience of the secured debt holders being young and there may be occasions that these peck may give birth in an irrational way to reduce the consumption.But such phenomenon can not be identified with a majority of debts. 3. The thir d argument was based on the fear that with more number of multitude the more will be the trouble when there is a collapse in the housing market. This fear has become true presently with housing boom bubble exploding. If house prices fall by 30 or 40 per cent, more flock with mortgages means more people in negative equity. Of course, the consequences of this depend to roughly extent on the behaviour of lenders.If the mortgage debt continues to be treated as secured, even though some is not, then debt servicing costs remain unchanged. So a lot will then depend on the collateral damage associated with the collapse in the housing market and what caused it in the first place. The issue is, if some disaster happens in the housing market, does the fact that more people have mortgages make the consequences very much worse? So much worse, indeed, that monetary policy should be used to discourage individuals from taking out mortgages. 2. 3 DIFFICULTIES OF CONSUMERS BECAUSE OF DEBT CREATI ON AN OVERVIEWAccording to a research conducted by R3 the Association of Business Recovery Professionals one out of six consumers find it difficult to manage the repayment of their secured loans and credit card payments. Of those struggling the most with their day-to-day finances, 21 per cent of respondents were reported to have encountered debt problems as a result of becoming ill, with a third (33 per cent) highlighting redundancy as the source of their monetary difficulties. (Secured Loan News) Educational loans taken for higher studies form a major proportion of debts to be repaid by the 50 percent people in the age group of 18 24 years.The same is the case with one third of the people in the age group of 25 34 years still struggling to settle the loans taken for their educational purposes. A study carried out by Abbey in early 2007 showed that the British consumers had to pay ? 48. 7 gazillion by way of upset(prenominal) bills and charges over the previous year. On an av erage 79 percent of the British people have spent money on unbudgeted things and the average cost of such spending is estimated at ? 1375. Some of the issues identified with the debt creation in the UK are? The face-to-face lending figures stood at ? 1,318 billion as of July 2007 signifying that the British consumers are indebted on an average twice as the citizens of other European Countries. The people with serious debt management problem are estimated at 7 to 9 one thousand million Britons. ? A majority of the people have no savings or definite plans for savings to meet any unexpected future expenditure. A proportion of less than 50 percent of the people only have made adequate provisions for meeting the exigencies of a drop in their income level or other serious financial difficulties.? Some important statistics indicate that a substantial proportion of the population suffer from serious financial worries and resultant stress due to the increase of their debt burden. These sta tistics show that 74% of British couples find money the most difficult subject to talk about 32% lie to their partners about how much they spend on credit cards 35% are kept awake at night badgering about their finances. ? According to the estimate from Bank of England around 50 percent of the people who have identified their debts as a serious burden on them belong to the lower income groups.It is the case with those people who live in the housing provided by the loca authorities are likely to live in debt burden at two times the average person has. ? Debts being burdensome on their own are also responsible for several other social problems and debt and these problems are interdependent on each other in terms of their cause and effect. Groups of people like those out of work, school dropouts, people from single heighten families or unemployed parents are more likely to have serious debt management problems. 2. 4 REASONS FOR DEBT CREATION Consumers obtain loans for different purpos es.Similarly people in different income groups and different strata of life opt for secured and unsecured loans for various purposes depending on their life styles and needs for different purposes. The main reasons cited for increase in the debts of the consumers is the increased availability of the loans, overspending and the confide to buy instantly doing major purchases like purchase of cars or spending on a foreign vacation. The debt management problems of majority of the British consumers have arisen due to these and other reasons most of which are emotional spending.However why people get into serious debt problem is a very complicated question to find the answers there for. Though there are several factors responsible for leading the consumers to severe debt problems the following are some of the major causes that create a debt trap for the British consumers 2. 4. 1EASY AVAILABILITY OF DEBT In recent years the economy of the country was doing extremely well resulting in lowe r rates of inflation, low interest rates and low levels of unemployment.This economic buoyancy there had been an increased demand for the credit and the cost of such credit was low. The highly competitive financial services industry had been innovative to find many a number of products to get the needs of various strata of people. Today over 400 mainstream financial institutions compete fiercely to satisfy consumer demand. (Lord Griffiths of Fforestfach) In this background it can be said that the easy availability of credit was the main reason for the creation of more debts by the average consumer.2. 4. 2 DIFFERENT TACTICS OF THE LENDERS TO ATTRACT THE PEOPLE Although the banks do not explicitly solicit or lure the vulnerable people to sell their financial services products, the products themselves have been so designed in addition to the lending practices of the banks to cross the vulnerable people. Such practices include war-ridden marketing a lack of transparency in calculati ng the cost of borrowing undue care in lending and a lack of data-sharing. (Lord Griffiths of Fforestfach)Though it cannot be said that the banks and other lending institutions purposely target the vulnerable people customers are often enticed into over-borrowing with disastrous consequences research evidence suggests there is a strong correlation between serious indebtedness, drug and alcohol addictions and family breakdown. (Lord Griffiths of Fforestfach) This often leads to a situation where the vulnerable people stand the chances of more likely to get into serious debt problems. 2. 2. 3 LOW FINANCIAL CAPABILITIESIt is observed out of a poll conducted in the year 2004 that 33 percent of the people in the UK are not confident enough to handle money issues and only 30 percent of them even knew the basic interest calculations which forms the basis financial intelligence. If this is kind of financial knowledge that an average British consumer has then there is no doubt that such pe ople may not be in a position to make sound financial decisions concerning their personal finances including availing of secured and unsecured loans.Such lack of financial knowledge will make them drown in serious financial struggle as a result of unmanageable debts they have contracted. 2. 4. 4 LACK OF SAVING CULTURE The trend of todays Britain is buy now and pay later as against the traditional way of living of saving money to buy assets. This has seriously delirious the saving habit of the people over the period of time. In the current scenario more than 50 percent of the British pensioners make a cut on their other needs to settle their annual fuel bills.The decline in the habit of saving is one of the main reasons for the increased debt problems. Unless the saving habit of the people change drastically the situation of debt problems is likely to grow into greater magnitude. 2. 4. 5 MATERIALISTIC ATTITUDE OF THE young SOCIETY The attitude of the society towards borrowing and i ts effects on life has considerably changed over the last few decades. Credit is no more considered as dangerous as it was perceived once upon a time. Now it is considered as more neutral and beneficial to the society.With this change in the attitude people have become more materialistic to obtain loans to buy the things irrespective of the need for such things in their lives. This is evident from the buying habits of British consumers exhibited in the following section. In one of the surveys conducted by Abbey, the financial service provider, it is learnt that Britons have spent more than ? 169 billion on items that they rarely, if at all, use. Overall the average consumer has paid out some ? 3,685 through unnecessary objects, which could consequently impact upon their ability to handle their day-to-day finances. (Secured Loan News) The survey also revealed that half of all consumers own an expensive clothing item which they wear only occasionally and over 35 percent of them have u nworn shoes. However, women were reported to be driving pointless fashion spending. Some 58 per cent of females were said to have unused garments, with this figure falling to 45 per cent for footwear. Meanwhile, spending on such products accounted for 45 and 23 per cent respectively among men. (Secured Loan News)Electronic items, computer game console or video cameras and cooking equipments, repeated purchase of fine china items, exercise equipments, beauty gadgets that are not frequently used are some of the other items on which the British consumers spend their money and create debts for themselves. However, financial problems could be particularly increased for those 288,000 people who have bought a second home in Britain which they claim to make little use of, which as a result may see them to struggle to make secured loan repayments. (Secured Loan News) 2. 5 LEVEL OF CONSUMER CREDITThere has been a steady growth in the consumer lending in the period during the 1990s to early 2000s. But the growth has been sluggish after the climb in the last decade. According to the statistics released by Datamonitor unsecured Loans and borrowing via other forms of consumer credit fell by 4. 5 per cent over the course of last year (2006) to ? 207. 8 billion. (Secured Loan News) Maya Imberg the financial service analyst from Datamonitor says A weaker labour market, combined with high consumer debts and weakened consumer confidence, meant that consumers cut down considerably on spending and aimed to repay more of their debts over 2006. The study also indicated that the debt outstanding for an average customer stood at ? 4,522 in Consumer credit debt for the year 2006, which is against the ? 4,510 recorded for the year 2005. This outstanding debt figure was corroborated by the statistics released by the financial charity Credit Action which estimated the debt due by an average Briton at ? 4,550 by way of debts obtained on unsecured personal loans, credit cards, overdrafts and other forms of borrowing. This amount was estimated as at the end of March 2007.Credit Action has compiled the following statistics on the UK personal debt as on 1st of September 2007 which is alarming ? summate UK personal debt at the end of July 2007 stood at ? 1,355bn. The growth rate increased to 10. 1% for the previous 12 months which equates to an increase of ? 117bn. ? Total secured lending on homes at the end of July 2007 stood at ? 1,140bn. This has increased 11. 0% in the last 12 months. ? Total consumer credit lending to individuals in July 2007 was ? 214bn. This has increased 5. 3% in the last 12 months.? Total lending in July 2007 grew by ? 10. 3bn. Secured lending grew by ? 9. 2bn in the month. Consumer credit lending grew by ? 1. 1bn. ? Average household debt in the UK is ? 8,856 (excluding mortgages). This figure increases to ? 20,600 if the average is based on the number of households who really have some form of unsecured loan. ? Average household debt in the UK is ? 56,000 (including mortgages). ? Average owed by every UK adult is ? 28,550 (including mortgages). This grew by ? 210 last month. ? Average outstanding mortgage for the 11.8m households who currently have mortgages is ? 96,560 ? Average interest paid by each household on their total debt is approximately ? 3,700 each year (this equates to 9% of take home pay). ? Average consumer borrowing via credit cards, motor and retail finance deals, overdrafts and unsecured personal loans has risen to ? 4,515 per average UK adult at the end of July 2007. ? Britains personal debt is increasing by ? 1 million every 4 minutes. (Credit Action) A pictorial representation of the growth in the UK personal debt is depicted below