Impact of the Credit Crunch on UK Borrowers Debt Mountain Going into 2008

By: Nadeem_Walayat

The credit crunch originally sparked by hedge funds in June going bellie up due to US subprime exposure, quickly spread to a freeze of the interbank money markets during July 07, and resulted in the first run on a UK bank for 150 years during September. The contagion has continued to spread with magnitude of the problem having grown from just $2 billions to now more than $1 trillion. With this inability to value debt packages leading to ever tighter lending requirements across the credit markets. This article evaluates the real impact of the credit crunch on the UK borrowers.

Mortgages

The mortgage sector has been hit the hardest by the credit crunch, gone are the days of easy mortgage credit where at the peak of the lending boom borrowers could self certify at more than X10 earnings. Now borrowers face a much more draconian lending regime which hits all borrowers across the board and not just the subprime. Variable mortgage rates have increased during the credit crunch by nearly 0.25%, this despite wide spread acknowledgement that UK interest rates are now heading lower. Normally mortgage interest rates would start to discount the move well ahead of the first cut in the UK Base interest rate, but the money markets have seen the LIBOR rate (the rate banks led each other) rise from 5.4% a year ago to 6.25% today. Hence the rise in mortgage rates.

The most popular home owner loans are 2 year fixed rate deals which continue to rise, hitting an average of 6.4%.

Buy to letters, the once cash cow for the mortgage industry has seen in one fail swoop the biggest player in the buy to let market, Northern Rock disappear from the market place, with other banks unwilling to take on high risk propositions from amateur landlords that at the first signs of the housing bust will be the first to throw in the towel and hand in their keys on the crest of a wave of repossessions. Typically banks are now focusing on high equity buy to let loans that require more than a 25% deposit at relatively high interest rates of 7%+ against average rental yields of 5% or and much less in many areas of the UK.

Additionally buy to let investors need to satisfactorly demonstrate that rental income will be able to more than cover mortgage interest payments. This means that now only the more experienced and capitalised buy to let players can afford to invest in the buy to let market. The days of 100%+ buy to let mortgages appear to have gone for good !

Credit Cards - The Next Credit Crunch?

Whilst the credit card spending continues to grow, as consumers strapped for cash continue to accumulate debt on their credit cards, what consumers will find on close inspection of statements is across the board rises in the minimum repayments from minimum 2.5% to 3% monthly repayments. Interest rates already floating in the 15% to 20% range have also been similarly lifted by an average of 3%. With the interest charged on cash advances surging by 5% or more to a typical 24% average.

Esther James, credit card analyst at Moneyfacts.co.uk – the leading independent financial comparison site, comments: “Its seems as if the credit crunch is beginning to cause credit card chaos. 125 fee and rate increases inside two months is quite staggering. With the majority of increases staying away from the headline purchase rates, these fee and rate increases are less in the public view, and often tucked away in lengthy terms and conditions. However they can still make a substantial increase to the cost of using your card.

“With Christmas coming up, incomes will be stretched to the max with more people perhaps turning to their plastic for access to additional cash, only to get stung by still higher rates and fees.

The number of credit card applications being refused is now more than 55% of applications with young people aged between 25 and 34 most likely to be refused a credit card, according to Moneyexpert.com , the price comparison website.

The growth in amount borrowed on credit cards accompanied by increase in charges and fees in the face of squeezed consumer, sets the scene for the next credit crunch in the credit card market, as banks packages of credit card debt that has been traded amongst banks becomes harder to value in the face of increased customer defaults.

Home Owners Strapped with Debt

The UK housing market has reached extreme levels of unaffordability as mortgage interest rates have risen and consumers burdened with more than £1.5 trillion of debt of which £1.2 trillions is mortgage debt.

Add to this the hidden inflationary costs of the surge in energy costs and council tax bills, just at a time when mortgage and credit interest fees are on a rise, which is resulting in UK consumers taking on even more unsustainable amounts of debt which is expected to contribute towards a surge in repossessions next year. The Market Oracle estimate is that repossessions will be 100% higher than that of this year and beat the record number set during the peak of the last housing bust, passing some 80,000 during 2008.

Economic Growth Will be Sharply Lower During 2008

The squeeze on the UK consumer as a consequence of the credit crunch, will continue to ripple out into the wider economy with expected growth to be substantially lower than the governments forecast of 2.5% growth for 2008, with the Market Oracle projected growth rate at just 1.4% for 2008.

The shortfall in growth will result in higher taxes and inflation as the government seeks to fill the gap between ambitious government spending plans and shortfall in tax revenues. The forecast for the UK's Budget deficit to shrink from the present £35 billions looks increasingly unattainable and is expected to rise further. This could trigger a sharp drop in sterling and hence contribute to inflation.

The government has yet to factor in the crash in the financial sector which will result in sharp drops in taxable profits amongst UK banks as a consequence of ever larger bad debt provisions, and we have yet to witness the contagions spread to the corporate sector, which is carrying its own large debt mountain.

Summary

The UK Borrowers both retail and corporate are being squeezed by the credit crunch which continues to spread as Banks suffer growing losses on mark downs on mortgage backed securities. The continuing decline in the US housing market and now the UK market will result in further losses during 2008 and therefore result in upward pressure on market interest rates despite cuts by the Bank of England of the base interest rate. Consumers saddled with record amounts of debt will be forced to reign in spending as a consquence of increased debt costs, energy costs, falling housing market, rising taxation and economic uncertainty.

By Nadeem Walayat
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Nadeem Walayat has over 20 years experience of analysing and trading the financial markets and is the Editor of The Market Oracle, a FREE Daily Financial Markets Analysis & Forecasting online publication. We present in-depth analysis from over 100 experienced analysts on a range of views of the probable direction of the financial markets. Thus enabling our readers to arrive at an informed opinion on future market direction. http://www.marketoracle.co.uk

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