What are the different kinds of debt?
The average UK adult is £30,575 in debt – and that’s without student loans.
When you borrow money, it can either be secured or unsecured debt. The main difference is that a secured loan means you borrow against an asset such as a house. So if you get a mortgage, the bank will own a part of your house until you’ve paid it off. The part you own is called equity. If you can’t pay back what you owe, the bank can repossess your house.
The interest on unsecured debt such as credit cards tends to be much higher. Such loans are more risky for the lender partly because there’s no asset to repossess if you can’t pay back what you owe. Certain types of borrowing such as overdrafts, revolving credit on your credit card and payday loans are also more expensive because they indicate that you’re having financial difficulties. This makes you seem like a risky borrower.
If you can’t pay back what you owe, whether it’s secured or unsecured debt, this can affect your credit rating. Having a bad credit rating will make it expensive and hard to borrow money. It can also affect your ability to rent a property, get a mobile contract and so on – anything that depends on a credit check.
What’s the difference between fixed and variable interest?
If you take out a fixed loan, the interest will stay the same for a certain period of time. A variable rate can change at any point, typically reflecting a change in our base rate at the Bank of England. When we raise or lower the interest rate, it mainly affects people with variable mortgages.
Most unsecured loans have fixed interest rates. Credit card rates are high and tend not to vary with base rate changes. But if you rely on unsecured borrowing and regularly need to refinance debt, you might be impacted by a base rate change.
Why does the Bank of England care about debt?
We try to control the pace at which prices in shops rise, known as inflation, by setting the key interest rate in the economy. If we reduce the interest rate borrowing becomes cheaper and people tend to spend more, meaning the economy will grow. When we increase the rate, the opposite happens and the economy cools down. If people are in a lot of debt, and much of it is on a variable rate, their spending will change by more if the interest rate moves. So we need to take this into account when deciding how much to increase or decrease the rate.
We also try to keep the financial system stable by making sure people’s debt doesn’t pose a risk to the wider economy. For example, we’ve created rules to limit the riskiest type of mortgage lending that banks do. And we test if the largest banks can cope with big losses from unsecured debt.