Household Debt - Household Over-indebtedness

Household Over-indebtedness

While it is challenging to define over-indebtedness, definitions of over-indebtedness tend to have a few core elements in common. The first one refers to the capacity to meet the expenses associated with the contracted financial commitments. Over-indebtedness implies an inability to meet such recurring expenses. Second, this inability is structural. This is the time dimension, which holds that the definition must capture persistent and ongoing financial problems and exclude one-off occurrences that arise due to forgetfulness, for instance. The third core element refers to standard of living. The household must be unable to meet contracted commitments without reducing its minimum standard of living expenses. Fourth, comes illiquidity. The household is unable to remedy the situation by recourse to (financial and nonfinancial) assets and other financial sources such as credit. Lastly, all contracted financial commitments are included, among them mortgage and consumer credit commitments, utility and telephone bills as well as rent payments (recurring expenses).

Causes of over-indebtedness can be diverse. A 'risky life event' (for example, unemployment, relationship break-up, leaving the parental home, business failure, illness or unexpected home repairs. Such events can trigger income and expenditure shocks) can lie at the root, sometimes instantly turning indebtedness into over-indebtedness. Other households have unconsciously, or consciously, gradually become overcommitted. They make use of available forms of credit, sometimes without realising that they might not be able to repay in the future. Lack of financial management skills and aggressive marketing by lenders may both lie at the origin of this. Another potential cause includes escalating consumption habits. The third group of people are the least well-off. They need to obtain credit in order to attain a reasonable standard of living. They are frequently subject to relatively high interest rates. Potential consequences for the over-indebted household include financial hardship, depression poor health, relationship breakdown, exclusion from basic financial services, a strain on social relations, absenteeism at work and lack of organisational commitment, a feeling of insecurity.

Responses to household over-indebtedness can be preventive, alleviative and rehabilative. Preventive measures include financial education and regulation. An example of the last is the European Union’s "Directive on Credit Agreements for Consumers Household debt advisory services". It stipulates, for example, that lenders should list the interest rates they change in a homogenised way (yearly rates) and that paper contracts should be signed for debts above a certain amounts, thus inhibiting for example impulsive borring through SMS-loans. Alleviative measures include debt advisory services, which aim to help households getting their finances back on track, mainly by means of information provision, budget planning and balancing, help with legal arrangements, negotiation with creditors, providing psychological support by having someone to talk to, and even by effectively, voluntarily taking over the managing of a household's finances. Rehabilitive measures include consumer bankruptcy and legal debt settlement procedures. While precise arrangements vary largely between countries, in general such procedures work as follows. During such procedures, the over-indebted household hands over all income above a minimum threshold to the creditors/state and is cleared of its debts after the period, varying in lenghth from for example 1 year in the UK to 5 in Portugal and 12 in Ireland.