Bank of England introduces new household debt affordability measure

The Bank of England has developed a new measure of household debt affordability, using the share of income available to repay debt after adjusting for an estimate of essential spending and taxes. The measure appears in the Bank's July 2022 Financial Stability Report, and was set out in an analysis published by the independent Responsible Credit on 5 August 2022¹.

The Bank's estimate of essential spending "includes utility and council tax bills, housing maintenance, food and non-alcoholic beverages, motor fuels, vehicle maintenance, public transport and communication"¹. The Bank says the measure "enables better assessment of the combined impact from rising prices and interest rates"¹.

The Bank sets thresholds at which households are judged more likely to struggle. The adjusted mortgage debt servicing measure is set at 70%, and the adjusted consumer credit debt servicing measure at 80%¹. Responsible Credit says the report does not explain the precise adjustment used to arrive at these levels¹.

Responsible Credit worked through what the thresholds mean for a household with median gross income of £31,400 in 2021, which it says spends around 50% of gross income on taxes and essentials, leaving disposable income of £15,700, or £1,308 a month¹. On its figures, such a household with a mortgage would need to spend 70% of disposable income on repayments, equivalent to £915 a month, to reach the Bank's threshold; with mortgage and consumer credit debt combined, the figure is £1,046¹. That would leave £393 a month, or £90 a week, for non-essential spending for mortgage-only households, and £60 a week for those with both types of debt¹.

Responsible Credit says the Bank estimates the lowest income decile is paying out 90% of disposable income on items it considers essentials, and the second and third deciles 60%¹. It adds that households in the lower half of the income distribution hold approximately 12% of all mortgage debt and a fifth of consumer credit debt, while the sixth income decile accounts for 7% of mortgage debt and over 10% of consumer credit liabilities¹. It notes that in the 1990s a mortgage repossession crisis was sparked by only around 2% of mortgages entering prolonged arrears of six months or more¹.

The Bank's Monetary Policy Committee raised the base rate to 1.75% on 4 August 2022, the day before Responsible Credit's analysis was published¹. The Bank is forecasting inflation will hit 13% by the end of the year and a recession lasting five quarters¹.

Why it matters for households

The measure changes how the Bank judges whether households are likely to fall behind on debt, by looking at income left after taxes and essentials rather than gross income alone. For a household on median income, the thresholds imply repayments of £915 a month on a mortgage, or £1,046 with consumer credit as well, before the Bank would treat the debt as a default risk¹. Responsible Credit argues the thresholds are set too high and that the definition of essentials omits items including childcare, clothing and footwear, personal care items, prescriptions and household appliances; it cites childcare costs averaging £138 a week, over £7,000 a year, for a part-time nursery place for a child under two¹. The Bank's own forecasts are for real household post-tax income to fall sharply in 2022 and 2023, with consumption growth turning negative¹.

What happens next

Responsible Credit has called on the Bank to publish the full methodology behind the adjusted debt servicing ratios and their thresholds¹. The Bank has not said whether it will do so, and no date for publication has been reported¹.