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Why it's important to repay our debts while we can

This week's Autumn Statement from the chancellor showed how precarious our finances are at both a national and a personal level.

 

by Gavin Lumsden on Dec 07, 2012 at 16:12

Why it's important to repay our debts while we can

The nation’s finances remain on a knife edge.

In his Autumn Statement this week the chancellor George Osborne was accused of fiddling the numbers by Labour after he used £3.5 billion of revenues from the sale of 4G licences to mobile phone companies that haven’t happened yet to claim that government borrowing had fallen.

Analysis by the Institute of Fiscal Studies showed this helped reduce underlying borrowing for this financial year to £120.3 billion, down a smidgeon from £121 billion in 2011/12.

Such are the wafer-thin margins on which Budget success or failure is based.

Even so Osborne had to abandon one of his two fiscal rules. The country’s debts won’t be falling by 2015/16, as the chancellor originally hoped, because the Office for Budget Responsibility – the ‘independent’ forecaster he set up two years ago – believes the economy will have shrunk a further 3.6% in four years’ time. A shrinking economy means less revenue for the Treasury, making this debt target impossible to meet.

This means a prolonged period of austerity beyond the next election, making it ‘inconceivable’ to the IFS that we can avoid further tax rises and deep spending cuts if we are going to balance the books.

It’s all rather depressing and shows the huge economic price we’re all paying for the financial crisis of 2008.

Continuing the theme of our precarious finances I was struck by a table in the Treasury documents accompanying the chancellor's statement that showed the impact a rise in interest rates would have on the UK. This is significant because of the huge level of personal and public debt.

Let’s take the latter first. The main measure of the country’s debts is the public sector net debt. This is set to hit nearly £1.2 trillion (or £1,186 billion to be precise) this year, rising to over £1.5 trillion (£1,534 billion) in 2017/18. 

These staggering figures represent around 75% of our gross domestic product (GDP) today rising to nearly 77% in five years, having, according to the OBR’s forecast, peaked at just over 79% in the previous year.

Do you think that’s bad? According to figures on the Credit Action website the total level of outstanding personal debt stands at more than £1.4 trillion. We, the public owe more than the government. It cites an OBR forecast that this will rise to over £2 trillion by 2017.

According to the charity, average household debt excluding mortgages stands at £5,934. Including mortgages, the figure rises to £53,912. The cost of servicing all this debt is around £60 billion a year.

Here is the alarming bit.

As we all know, interest rates have been held at an all-time low of 0.5% for nearly four years. The cost of borrowing is not expected to rise until at least 2015 but at some point it will rise, with interest rates possibly regaining the 5% level they were at before 2008.

According to the Treasury a 1% rise in mortgage rates would add £12 billion a year to homeowners’ loan repayments, ie, a fifth more than they are paying already according to the Credit Watch figures. You can see how further rate rises beyond this could cripple many households' finances.

The situation for the nation is just as bad. A 1% increase in the country’s cost of borrowing would add nearly £22 billion to the country’s interest payments over five years. A 4% rise would plonk another £90 billion on top of the nation’s bill.

I’m not saying there is an imminent threat this is going to happen. However, with Fitch, a credit rating agency, warning this week that it might drop our top AAA credit rating next year, we can’t afford to be complacent.

The lesson for your personal finances from all of this is that now is the best time ever to pay off your debts while interest rates are historically low. With savings accounts and cash ISAs paying a meagre 2-3% at best, you get a better financial return focusing your attention on your mortgage, where standard variable lending rates stand at around 4- 5%.

Of course many people have got the message. Credit card borrowing is down and there have been signs that households are prioritising mortgage repayments. But with the government set to squeeze our wallets a lot more to repay the national debt, it might be time to make an even bigger effort to reduce our personal indebtedness.

14 comments so far. Why not have your say?

Keith Cobby

Dec 07, 2012 at 17:48

We have been told for the last five years that interest rates must return to more 'normal' rates but I do not understand why. Interest rates charged to consumers no longer have any relevance to the base rate and surely the BoE will continue to manipulate the rates through QE indefinitely.

The past is a foreign country we can never go back to what we considered 'normal'. The economic centre has moved east and there is little we can do about it when our 'democracy' cannot plan further ahead than five years.

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Jon

Dec 08, 2012 at 09:14

The financial crisis of 2008 did not cause this debt problem. It was simply the symptom of many years of people and government spending huge amounts of other people's money without any repayment plan, plus growing off balance sheet liabilities. All this whilst the UK had a huge trade deficit.

Increases in interest rates need not cripple the economy as one man's cost is another man's income. Savers will have more to spend and will no longer be taxed on their capital in real terms. It simply means that borrowers will quite deservedly have to trim their budgets - they have had it too good for too long. Government spending will have to reduce to around 33% of the GDP for a healthy economy, and we will have to buy less from overseas.

Getting there will be painful, but well worth it

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Geoff Downs

Dec 08, 2012 at 09:59

Don't hold your breath. I also think you underestimate the effect of interest rate rises on families, already struggling with debt.

Of course as a saver I would like to see rates rise, but it won't happen.

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In the Dark

Dec 08, 2012 at 12:12

@Jon

Quite right, Government spending is far to high and needs to be brought back to manageable levels, I would also agree that 30-35% of GDP is a reasonable target to aim for and is sustainable in the long term. But and a big BUT we ie me and you have to practice what we preach and cutting our debt is a priority.

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Dividend Income investor.com

Dec 08, 2012 at 16:26

Not necessarily all our debts; it depends on the type of debt.

With interest rates currently at record low levels, the only way . . . is up . . . . at some stage, in particular once higher inflation takes hold which is likely to happen (at some stage) due to UK's version of quantitative easing and the ongoing debasement of Pound Sterling.

IF you need to be in debt make sure that you repay all your debts which are based on variable interest rates, as your interest repayments will go up if and when the before mentioned scenario unfolds.

Want to sit pretty, if and when inflation is about to take of, and, if you have a variable interest rate mortgage now, consider remortgaging it into a long term fixed interest one and let increasing inflation do its work with regards to your outstanding fixed mortgage debt and fixed interest payments.

The only thing you now need is the certainty of sources of income (preferably inflation adjusted) to be able to service your debt and interest repayments, such as above inflation growing dividends.

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Frankie Dee

Dec 08, 2012 at 16:46

I have seen my income decrease 75% since 2009 the work I could enjoy in the leisure industry has vanished I could work 6 nights now Fri & Saturday without historic low interest rates I could not keep my home I have done nothing wrong I am simply a victim of the situation.

If my work levels stayed the same with a decrease in mortgage rates to 0.5%

I would be getting 600 a month free money not using it to make it through the month Im sure there are some people living the low interest dream so low interests work to help families but for the lucky ones a nice windfall.

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Jon

Dec 08, 2012 at 21:38

Most mortgages were taken out long before interest plummetted, so the borrowers should have budgeted for far higher interest payments than they are making now. They have enjoyed a bonanza at the expense of savers, so they should not complain if rates rise back to where they were in a few years' time.

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Anthony O' Grady

Dec 08, 2012 at 22:12

Keith

Too Much QE will explode in the Govts face. If external Gilt investors finally conclude (which they will) that the Govt is deliberately attempting to debase sterling, then gilt yields will fall because investors will want more yield. Also existing investors may want to bail out before the redemption date, as this might be preferable to being repaid in seriously devalued sterling. Ultimately, the bond markets will determine Britains mortgage rates, not the BOE. As Gerald Celente neatly puts it, state sponsored capitalism is fascism.

Don't believe in the myth that the Govt can keep mortgage rates down for as long as it wishes. A full blown sterling crisis will soon put that theory to bed.

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Forestbhoy

Dec 08, 2012 at 22:33

What jon says is spot on.How about going back to the "old fashioned" idea of not buying what you cannot afford ?? Advertising and marketing,along with goverment(s) policy,has created a feeling that what you can't afford now,you can buy,because wages/house prices(for credit) will go up tomorrow........tomorrow never comes ....

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Anthony O' Grady

Dec 09, 2012 at 08:17

Jon

Your comments are, by and large, agreed.

However a 2/3 per cent increase in mortgage rates won't just mean that hundreds of thousands of households (millions) will have to trim their budgets. These people are already on the brink. What it will mean is bucket loads of re-possessions, and another 30 per cent off house prices.

For the housing market this would in my view be a healthy adjustment, and would give younger people a better opportunity to own their own home. My own view is that UK gilts are in classic bubble territory, and that a sovereign bond/sterling crisis is inevitable. Pinpointing precisely when it will happen is more difficult, but when it does happen our beloved housing market will be savaged.

Speaking as someone who has no mortgage or other debts, I would welcome the idea of higher savings rates. For the last five years the prudent have been punished for the hubris of others, and the profligate have been sheltered, in my view undeservedly. However even if interest/mortgage rates rise dramatically, don't count on investment account rates rising in lock step. The banking system in Europe is still shot to pieces, and banks will take ever opportunity they can't to bolster their capital.

Economically, the west is now living in a parallel universe with years of misery to come.

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Anthony O' Grady

Dec 09, 2012 at 08:26

PS- not wanting to miss the essential point of the article, I agree that paying down debt is a no brainier in the current environment. However, the extent of the deleveraging required, will curtail economic growth for years to come.

One more point - cutting public spending. I know that we are all very proud of the NHS etc, but the Dept of Health is by far the biggest spending Dept. It's budget dwarfs the rest of Whitehall. Eventually the Govt will have to retreat from the idea that the health service budget should be ring fenced. We are all going to have to accept that the NHS simply can't deliver everything that we want.

The final point isn't relevant to the article, but is I believe a point well made.

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William Phillips

Dec 09, 2012 at 21:25

I'm not proud of the NHS. I am sick of paying taxes for a lousy, disease-breeding, statist service I haven't needed to use for more than 30 years-- just as I am sick of being told that 'we' are to blame for borrowing too much when I have managed to live on this earth for 60 years without ever being a penny in debt.

When I wanted something I saved for it, and that includes my home. Debt is slavery. As Jon says, the 2008 crisis was the bursting of an abscess that had festered for decades, encouraged by cowardly 'leaders' pandering to the financial illiteracy of the self-indulgent mob who wanted to be enslaved in exchange for the trumpery novelties of consumerism, like pigs being driven to market.

If more Britons shared the attitudes of Jon and Anthony O'Grady, we would never have fallen into this slough of despond, and we the minority of proudly self-reliant and provident people would not suffer the leaching away of our savings from inflation and joke interest rates, so that profligate mortgagors could be spared the consequences of overpaying for their rabbit hutches a little bit longer.

Housing crash? Bring it on-- at least the young will get a shot at ownership at last. Privatise the NHS, make those who have drunk, drugged and over-ate themselves to perdition pay the full cost of their treatment. Let the parasitical banksters go to hell in a handcart and let's start rebuilding this country from the foundations up, on the basis of morality instead of moronic consumerism and stealing from generations unborn.

The society and economy we have cannot be patched up much longer. A systemic tsunami is need to flush away the accumulated filth and debris of its failure. It will be every man for himself instead of the 'funnermental yooman rite' to be subsidised by your betters, and for the world and his civil partner to be given the red carpet treatment as immigrants.

Who knows, we might even get genuine, small-scale free enterprise out of it instead of crony capitalism, what Milton Friedman called pension fund socialism and subservience to the nation-killers of the EUSSR.

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Geoff Downs

Dec 09, 2012 at 21:54

Growth in State debt which helps to fuel growth in the economy is O.K.and positive.

If growth in debt exceeds growth in the economy then that is seriously bad, and that is what we have now.

Regarding personal debt, it is true we have gone through a period of easy credit which has rendered many citizens with significant debt problems.

There is no doubt are economy is unstable, facing great risks. What would dangerous though is to try and correct the errors by enacting policies that would seriously threaten the well being of many people.

Regarding the NHS. There is no doubt waste and some issues over care and treatment. To vilify it would be wrong as it carries out lots of work that benefits people at their most vulnerable time.

Socialism does not work but we need to be careful of raw capitilism.

We don't want raw capitilism for the workers and soft socialism for the bankers.

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Paul Barrett

Dec 12, 2012 at 18:57

Until banks are prevented from being able to offset their losses against corporation tax and prevented from converting 'unsecured debt'. of which there is NO such thing;to secured debt then irresponsible lending will occur.

The banks are always in a win, win situation.

Anyone who has an unsecured debt should continue to have it unsecured.

The law presently allows any debt to be secured against assets.

I am sure if consumers understood that there was NO such thing as unsecured credit; their spending mindset would change.

The put it on the plastic mentality would soon change if the consumer realised that not servicing that debt could result in losing the family home or being pursued for the rest of their lives if they ever come into assets with any value.

Of course it is not in the bank's interest to state that in the event of non-payment your home may be at risk and we will come after your assets and wages to repay everything you owe us.

If that was put at the head of credit card and loan applications, a bit like fags then borrowing on the never, never would rapidly reduce.

Then people might start SAVING for things they WANT, but don't NEED!

Of course govt doesn't want this to occur as it needs credit to sustain the illusion we have a vibrant economy.

We don't; it is all based on the illusion of credit rather than wages.

This economy is a low wage economy and irresponsible credit is needed to keep the whole charade going.

Remember when 'we are all this together' , Cameron, suggested everyone should pay off their credit card bills!!!....................Until someone in the real world advised, doing that would take 6% GDP out of the economy!!!

He soon backtracked.

It would be god to have a PM who is on a the min wage and would appreciate the difficulties low ages bring.

Of course the elephant in the room is immigration.

We have imported 7 million immigrants; pray tell why!

We have 7 million unemployed, underemployed or not bothering to seek work of our own on some sort of benefits.

Immigration where necessary; like Australia does things., fine

Do we really need any more low skilled waitresses and cleaners from the Accession countries.

Could we not return them and employ all those on benefit to do those jobs.

Whilst we have unfettered EU and non-EU migration low wages WILL persist and govt WILL have to spend ever more on welfare.

It is the economics of the madhouse; importing unecessary immigrants to do jobs that we can do with our existing population.

We need to stop ALL immigration NOW.

Using an Australian points system we allow immigrants we want.

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