Cost of living - effects on debt: review of emerging evidence

2. Introduction

Being in some sort of debt or using credit is extremely common. The Financial Conduct Authority (FCA) estimate that across the UK nearly four in every five adults - over 41 million people - hold some form of credit or loan regulated by the FCA^[1]. Debt is not intrinsically good or bad and it can be ‘socially and economically useful’ to individuals, households and the economy.^{[2] [3] [4]} Debt is a vital commodity for households who might not otherwise be able to purchase goods and services in the short term and during periods of low household income. It can help smooth incomes and meet both expected and unexpected bills, or make possible longer term investments such as taking out a mortgage to purchase a home.^[5] Debt can also be good for the economy, helping to boost economic growth in the short term.^[6]

Most people with debt do not experience significant problems repaying it.^[7] However, when levels of household debt or repayments become too high or unsustainable, or when credit is used as a safety net by those in financial difficulty, it becomes harmful. Definitions vary, but broadly a household is in unmanageable or ‘problem’ debt if they have liquidity or solvency problems, or both. Liquidity problems mean people struggle with their debt repayments and are falling behind with bills. Solvency problems mean people have a large amount of debt and feel heavily burdened by it.^[8]

Unmanageable or ‘problem’ debt can reduce a household’s ‘financial resilience’ (through over-indebtedness or having little capacity to withstand financial shocks), and make it more difficult and costly to keep up with repayments on outstanding debts as further costs and fees accrue. Problem debt can have devastating and long lasting consequences, and is harmful to mental and physical health. ^{[9] [10] [11] [12] [13] [14] [15]}

2.1 Definitions

Household debt is money borrowed, usually from banks or financial institutions, by individuals and typically refers to a broader picture of debt accumulated across the whole household, including the personal debt of multiple adults and expenditure related to dependents.^[16] The term personal debt refers to debt accrued just to the individual. Technically there is a distinction between household debt (which includes mortgages, personal loans, car loans, student loans, the balance on credit cards and overdrafts on bank accounts) and personal debt (which also includes mortgages, overdrafts, credit cards and student loans). However, in practice there is a high degree of crossover between these two terms. The majority of evidence sources in this report refer to personal debt.

Personal and household debt can be secured or unsecured debt. Secured debt is a loan secured against an asset to serve as collateral for the loan, such as a house. If the borrower cannot repay the debt owed, the lender can repossess the asset and because the risk of default is low, interest rates tend to be lower.^[17] Unsecured debt is a loan provided to individuals that is not secured on an asset, such as consumer credit debt. The interest on unsecured debt such as credit cards tends to be much higher.^[18]

Priority and non-priority debt are terms used in the literature to describe the different consequences of non-payment in terms of severity.^[19] Priority debts have particularly serious consequences for people who do not pay them and can risk a person’s home and health (e.g. non-payment of rent/mortgage leading to homelessness, or non-payment of energy bills leading to the withdrawal of essential services), and can cause legal problems and lead to more debt.^[20] Non-priority debts have less serious consequences if unpaid, and creditors are required to follow a collections process before resorting to more serious action.^[21] Examples of non-priority debts include personal loans, credit card debt and store cards (all unsecured debts). Lastly, ‘deficit or negative budgets’ refers to when a household’s income, whether from wages or social security, falls short of covering essential outgoings.

2.2 Debt and the cost of living crisis

The cost of living crisis was caused by a rapid and sustained increase in inflation in late 2021 and 2022 which meant that prices increased at a faster pace than household incomes.^[22] While the economic picture has been improving over the course of 2024 with inflation down to around 2% by summer 2024 (from a peak of 11.1% in October 2022), many households are struggling with debt. This report considers the evidence on the effects of the cost of living crisis on problem debt in Scotland, addressing the following research questions:

• What types of debt are households experiencing and how has this changed over the cost of living crisis?
• What are the characteristics of households and individuals experiencing problem debt and how has this changed over the cost of living crisis?
• Have demands on debt advice services changed over the cost of living crisis?

2.3 Approach

The report was written between July and October 2024 and involved a review of 125 relevant evidence sources. A Scottish Government library search for academic and other literature focusing on the time period 2021-2024 was conducted. In order to understand the impact of the cost of living crisis, this report mainly draws on evidence published after 2022, but where relevant high quality older studies are included. The report focusses on evidence relating to household and personal debt in Scotland, but also draws on UK wide evidence. A wide range of sources are included to address the research questions posed, including official statistics, self-reported survey data (estimates of how much debt people have and whether they can afford certain payments), commissioned research, academic evidence, reports by think tanks and debt advice services.

2.4 Limitations

This review was carried out in a short timescale and while it aims to be comprehensive, it is not a formal critical appraisal of the evidence on debt in Scotland. Student loans are different to other forms of debt (with repayments determined according to a person’s income levels) and so are not included.^[23] There are a number of caveats around the data presented from debt advice services - different methods and approaches are used to collect data and so direct comparisons between debt advice service data should be treated with caution.