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2 Exploration of debt

The third term that you’ll see or hear in the media is credit, defined as an arrangement to
receive cash, goods or services now and to pay for them in the future. It has been argued
that there is a rather subtle distinction between debt and credit, which has been described
as follows: ‘Debt is the involuntary inability to make payments which the payee expects to
be paid immediately, as opposed to credit use, which can be characterised as agreed
postponement of payment’ (Furnham and Argyle, 1998, p. 113). So debt can have the
sense of being more involuntary than credit – and debt is traditionally associated with debt
problems, which we shall be looking at later in this course. It is perhaps not surprising that
the part of the UK financial services industry concerned with lending money is known as
the ‘credit industry’ rather than the ‘debt industry’. However, the crucial point – just as with
the distinction between debt and borrowing – is that an amount owed at a particular point
in time, no matter how it has arisen, is a liability.
Some 85 per cent of the UK’s £1.46 trillion of personal debt in 2010 is accounted for by
mortgages. Debts such as these are known as secured debt, meaning that the amount
owed is secured against assets – in this case houses – which can be ‘repossessed’ and
sold by the lender if repayments are not made by the borrower. Debts that are secured on
housing are known as mortgages. Other types of debt are known collectively as
unsecured debt. In 2010 these represented some £220 billion or 15 per cent of the total
(Bank of England, 2010a). Unsecured debt includes money owed on credit cards, retail
finance, overdrafts, mail order catalogues, and other types of personal loans. If
repayments are not made the lenders will still seek to recover the money lent – often by
using debt collection agencies. However, since the debt is unsecured, the lenders have no
right to the specific assets that may have been acquired with the borrowed money.
Levels of personal debt have changed over time, growing steadily in the 1980s, then more
slowly in the early 1990s – largely as a consequence of falling house prices, which
reduced the size of demand for mortgages – and growing rapidly from the mid 1990s until
2007, then slowing significantly during the subsequent financial crisis. Notwithstanding
these variations in the rate of growth, the overall picture is that personal indebtedness in
2008 was substantially higher than ten, twenty or thirty years earlier. One consequence
has been that the ratio of total personal debt to total after-tax household income has risen
materially. As you can see in Figure 2, between 1987 and 2009 the ratio of debt to
household income increased from 0.8 to over 1.5 (BIS, 2010). Following the financial
crisis the debt-to-income ratio declined, as is also shown in Figure 2. This ratio had risen
to 1.6 by the onset of the financial crisis in 2007, at which point it levelled off (Bank of
England, 2010a; ONS, 2010a). This means that up to 2008, a period of time when
household income was growing, levels of debt were growing even more rapidly. The
inference is that the burden of debt on households over this period was therefore growing
– since more debt means that greater sums have, eventually at least, to be repaid. From
2008, the fall in the ratio could be explained by households paying down debt and being
more reluctant to take out new debt.

Figure 2 Total household debt to income ratio, 1987–2009 (secured and unsecured debt)
Source: BIS, 2010, p. 5, Figure 1

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