LONDON (Reuters) - Millions of Britons are set to experience the first interest rate rise of their adult lives on Thursday, and for some of those who loaded up on cheap credit to pay for cars or cards, that could spell trouble.
The Bank of England is widely expected to hike borrowing costs for the first time in a decade, signalling an end to years of low rates that fuelled a rise in ultra-cheap credit and heavy borrowing on loans, cards and, most notably, cars.
Regulators have clamped down on many of the riskier lending activities that thrived before 2008, from ‘payday’ loans with annual interest of over 5,000 percent to self-certified mortgages. Others, like motor finance, have risen to take their place.
Bankers and economists warn that those most indebted could begin skipping payments on cars and credit cards, puncturing a consumer debt bubble ten years in the making.
A 0.25 percent rate hike would lead to a median increase in monthly outgoings of 20 pounds for consumers who have contacted StepChange in the last year, according to calculations by the debt advice charity.
That would push the budgets of up to 7,000 of the charity’s clients into the red, meaning they can no longer cover essential living costs.
“Our view is that this isn’t mortgage apocalypse, but there’s a narrow group of people whose household finances are on a knife-edge and a rate hike could be the straw that breaks the camel’s back,” a spokesman for the charity said.
Consumer credit has grown much faster than household incomes in the last few years, the Bank of England said in June.
In September, it hit 204 billion pounds ($269.52 billion), with car finance the fastest expanding area that now accounts for around 30 percent of the total.
Last year, 86.4 percent of all new car purchases utilised some form of credit, up from 46 percent in 2006, according to data from the Financing and Leasing Association.
Most deals are done not by banks but through car manufacturers’ finance arms, with those from Volkswagen (VOWG_p.DE), BMW (BMWG.DE), Ford Motor Co (F.N), Toyota Motor Corp (7203.T) and Renault (RENA.PA) the biggest in the UK by the amounts they are owed by consumers.
These have risen from 13.5 billion pounds ($17.81 billion) in 2008 to over 36 billion pounds in 2016 - a 168 percent increase, data from the five firms’ financial statements show.
With credit widely available, a small but significant number of borrowers have become overburdened with multiple debts, said Peter Richardson, analyst at Berenberg.
Fifteen percent of mortgage loans are worth more than four times the borrower’s income, he said, up from less than five percent in 2005.
Most consumer credit is offered on fixed interest rates, so would not be directly impacted by a rate increase.
But with around 40 percent of mortgage lending on variable rates - and borrowers more likely to default on other loans than miss payments on their home - even a slight hike could leave the most overstretched people choosing to skip other debt payments.
A 0.25 percent interest rate hike would increase the monthly payments on an average floating rate loan of 140,000 pounds by around 15 pounds a month, according to Nationwide.
“If you look back at the economics of this ... borrowers with that level of indebtedness become very, very sensitive to shocks, you have much more violent reactions,” Berenberg’s Richardson said.
Cut-throat competition among lenders has driven rates on personal loans down.
For example, four lenders - TSB, Zopa, Sainsbury’s Bank and CYBG - offer short term unsecured personal loans of 20,000-25,000 pounds at fixed interest rates of below 3 percent, cheaper than many mortgages.
Royal Bank of Scotland Chief Executive Ross McEwan said on Friday growth of 10 percent per year in unsecured credit is unsustainable when wages are growing at just 2 percent.
“At some point it needs to slow down.”
Bank of England data shows that outstanding lending on credit cards was at an all-time high of 69.4 billion pounds in September and approaching its pre-crisis peak for other credit lines including overdrafts, personal loans and car finance.
Outstanding lending on these credit lines hit 134.8 billion pounds in September, compared with 138.2 billion pounds in August 2007.
Banks are, however, seen as stronger than when rates last went up in 2007.
As part of tougher regulations introduced since 2007, they are now required to hold more capital against their loans.
In September, the central bank ordered they increase this by a further 10 billion pounds to protect against potential losses on consumer credit, which it said were being underestimated.
Lenders with a particularly high proportion of consumer lending in their overall loan books could still be vulnerable in a downturn, however, ratings agency S&P said in a report last month.
It highlighted supermarket-owned lenders Tesco Bank Plc and Sainsbury’s Bank, which both have consumer credit portfolios in excess of 200 percent of their core capital.
“Our customer lending is subject to stringent and robust creditworthiness and affordability assessment tests,” a spokesman for Tesco Bank said.
“We are a responsible lender with a strong capital base, and a low risk approach to consumer credit,” said a spokeswoman for Sainsbury’s bank.
Richardson likened regulatory changes to make banks behave more prudently to street lights on a dark and dangerous road.
“We’re now at the bits where the street lights run out.”
Reporting By Emma Rumney and Lawrence White; Editing by Mike Collett-White