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There is a new expression which has recently come into use within the English language, invented by economists and gleefully pounced upon by the Media. It seems almost impossible, at the moment, to watch the evening news, or turn the pages of any newspaper without finding an article somewhere about the “Credit Crunch” which, apparently, is currently gripping all of us living in the UK today.

But what, exactly, is a credit crunch? How has this occurred and what are the implications for the average person in the street? There is no single factor to which this can be attributed, but several events and situations which have developed over recent years have caused the UK economy to slow down steadily and force banks, building societies and other financial institutions to tighten their belts and adopt a more cautious approach to lending money through loans, mortgages and other credit agreements.

The underlying problems lie with the ever increasing levels of consumer debt in the UK, coupled with a slow down in the UK housing market, along with other factors such as the recent problems in the American Sub-Prime loan and mortgage market. These factors, once combined, have caused a ”crunch” which has not only impacted on individuals, but has also claimed several institutional victims along the way, the most notable of these being Northern Rock, whose recent collapse caused shock waves throughout the financial sector, knocking confidence in an already fragile industry and exacerbating the downward economic spiral. Let us look in more detail at these areas:

Debt levels for individuals living in the UK today are now at record levels. Recent figures from Standard and Poors estimate that the average person in Britain currently has £24,500 worth of debt and this figure is still rising at an alarming rate. We appear to be living in a culture of “buy now, pay later” and many individuals are finding themselves in financial difficulties due to their level of loan and credit card commitments. The day to day affordability of these debts has been made worse by steadily increasing interest rates on UK loans and mortgages over the last couple of years, to the point where some individuals are actually paying out more on loans per month than they actually receive as income. Clearly, this situation cannot continue for long and therefore it is not really a great surprise to find a large increase in the number of people falling into arrears and defaulting on their loans and credit cards. There are now more and more individuals with County Court Judgements for bad debts. In the last twelve months we have seen a record number of Individual Voluntary Arrangements (IVA’s) and bankruptcy’s being registered. This is having a huge impact on lenders across the market place, as they are having to write off large sums of bad debts. This, coupled with an increase in the rate at which banks lend to each other, known as the LIBOR (London Inter bank Offered Rate), has meant that many lenders have been forced to severely restrict their lending criteria, with some even stopping lending all together. Obviously, the main blame for this situation lies with those individuals who have over committed on their borrowing, without regard for the consequences of their actions. However, the banks and other lending institutions must take some responsibility, due to their loan and credit card marketing campaigns and over relaxed lending criteria in recent years.

One of the largest influencing factors on the UK economy is the housing market. If people are buying houses, or moving house, this has a knock on effect in other areas such as the building trades and retailers. People want new furnishings in their new home, or a new kitchen, bathroom or conservatory. A buoyant housing market reflects a certain amount of confidence in the economy. Indeed, the UK has managed to avoid recession in the past due to a healthy housing market. Over the past few year’s house prices have risen at an alarming rate, well in excess of average salary increases and inflation. This is all well and good if you already own your own home, as the equity you hold within your property is greatly increased and can therefore be used towards the next move to a larger house, lessening the blow of high prices. The future of the housing market, however, lies with first time buyers, those young people wanting to get their foot on the first rung of the housing ladder. First time buyers are finding it increasingly difficult to be able to afford to make that first purchase, as the prices of even basic properties are often beyond their reach. This creates the necessity for either a much larger deposit than the usual 5%, or a lender who is prepared to offer increased income multiples on mortgages, over and above the traditional three times salary. Both these options present problems and often dissuade potential first time buyers from entering into the housing market. Ten years ago the average age of a first time buyer was early twenties. This average age has now increased to late twenties, with some even leaving it until early thirties before making their first house purchase. The other main factor, which has caused a slowdown in the housing market, has been steadily increasing interest rates on mortgage loans. The Bank of England base rate has increased from 4.5% in August last year to 5.75% in July of this year and although this has now levelled at this rate, many individuals find that the monthly mortgage repayments are unaffordable at these levels. Many existing borrowers, who borrowed large sums on stretched income multiples a few years ago, are now also having difficulty in keeping up with their new increased mortgage loan repayments, resulting in an increase in mortgage arrears and repossessions.

The other factor affecting our economy has been the problems in the American Sub-Prime mortgage and loan market. The US sub-prime market is much larger and has far less security than that of the UK and the problems it is now facing is largely due to irresponsible lending. Nevertheless this is having a knock on effect on our own sub-prime market, to the level at which many lenders are finding they are having to severely restrict or even stop lending in this area of the market. Some observers may question why on earth does the American market influence the UK to such a large degree, but the reason for the current problems for UK lenders is that many of them have previously underwritten sub-prime loans in the US which have defaulted, leaving them liable for the debt. The old phrase seems to be particularly true in this case, when America gets flu, Britain catches a cold!

It’s all very well to talk about the state of the economy and the various factors which are influencing the slow down we are currently experiencing, but the average person in the street is obviously more concerned with what this all means to them and, more to the point, how it will affect them.

Both the Government and the Bank of England are concerned over the economy and are taking action to try and reverse the current trend. Money is being made available to flailing lenders to cover their debts and encourage future business. Interest rates have been reduced last month for the first time in two years and we are likely to see further reductions over the next twelve months, which will help those of us with mortgages and also hopefully revitalise both the housing and retail markets. Both mortgage lenders and loan companies are now taking a more cautious view with regard to their lending criteria, which should provide them with more security over the longer term. Market statistics suggest that due to the slow down in the housing market, prices are likely to drop, at least over the short term, making housing more affordable, particularly for first time buyers.

To summarise all of the above points, there are some positive and negative likelihoods over the next twelve months or so. On the positive side, those individuals who already have a mortgage, particularly on a variable rate, are likely to see a reduction in their monthly repayments as interest rates decrease. This also has a positive effect on affordability for first time buyers, along with the fact that the housing market has slowed and house prices are possibly going to reduce, there is more potential to negotiate a reduction in purchase price with the vendor. On the negative side, due to the additional recent pressures on lenders, it will probably harder to obtain finance in the form of loans or mortgages, particularly if an individual has a poor credit history, or is requiring a large loan relative to their income. Although the tightening of lending criteria has been considered a negative point over the short term, in the long term this is likely to be a great positive as individuals will not be allowed to over-borrow in the future and this, hopefully, will ease the pressure currently being felt on the economy. Things can change very quickly indeed in the financial industry, and the overall recommendation for the future would be to watch this space!