An empirical model of household arrears

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Published on 09 March 2004

Working Paper No. 214
By John Whitley, Richard Windram and Prudence Cox

Household arrears on payment obligations are one of the most direct measures of household sector financial stress. This paper uses a time series approach to model two of the key components of aggregate UK household arrears: those on mortgages and credit cards. Mortgages are the main component of secured borrowing by households and credit cards are a key element in unsecured borrowing. Recent data show that both secured and unsecured debt have risen substantially, both absolutely and as a proportion of income since 1997. Unsecured debt has increased more rapidly over this period and so has become more important in overall household debt. During this period of rapid debt accumulation, the proportion of mortgage loans in arrears has fallen but the value of credit card arrears relative to the value of active card balances has risen. The paper explains these differences in the behaviour of arrears by reference to the underlying driving forces identified in previous empirical work. In particular the level of housing equity appears to be more important in explaining mortgage arrears, and the role of supply factors is highlighted for credit card arrears. Although the estimated models confirm that both income and interest repayments (and therefore income gearing) are important factors in explaining both forms of arrears, unemployment only plays an additional role for mortgage arrears. Joint testing of the two models suggests a role for the ratio of the value of the mortgage loan to the value of housing equity for both kinds of arrears, but with opposing effects. In the case of mortgage arrears this might reflect the lenders’ perceptions of the quality of the borrower. Credit card arrears appear to contain some information about future mortgage arrears although the reverse does not hold. Both equations adjust relatively quickly to any shocks, typically in around two years. The significance of the income-gearing term for both types of arrears underlines the importance of the path of interest rates for the financial position of the UK household sector.

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