Red alert on debt mountain

Mortgages that let you borrow 25 per cent more than your home is worth; credit cards at zero per cent and car loans at up to half the interest charged five years ago. With the prospect of even cheaper borrowing after last week's cut in bank base rates, it seems borrowers have never had it so good. Or have they?

Consumers appear to be gorging themselves on cheap credit. We borrowed ?1.3bn more on cards and in personal loans in June than in May. This was more than economic analysts expected. June mortgage lending grew by ?4.26bn, helping to take fresh household borrowing to ?5.8bn.

Simon Rubinsohn, chief economist at stockbroker Gerrard, says that by one measure, British consumers now owe more than their American counterparts. This measure is that our total consumer debt is 10 per cent higher than total disposable income. Rubinsohn says our figure includes mortgages, which the US ratio does not.

Even so, the figure is a signal for caution among borrowers.

He points to another trend: we are cashing in on rising house prices by borrowing against the equity to finance other spending. This has increased sharply over the past few months and is now at its highest level in a decade, he says, although consumption financed like this is still at a relatively modest 2.5 per cent, compared with the 9 per cent it reached in 1988.

Rubinsohn, in common with many other economists, expects a slowdown rather than a deep recession. Even so, he says, "there are undoubtedly risks".

"e are in the happy situation where the economy is growing, unemployment is falling and interest rates are low."

But he warns: "This is not sustainable in the long term."

Nationwide building society warned last week that house prices cannot continue to rise at the levels seen recently. The average price of a property rose by 10.9 per cent in the year to July. Some commentators believe that prices in some parts of London could fall.

Rubinsohn says: "I think people have to be circumspect in their enthusiasm for the property market. They should be cautious about the extent to which they are willing to finance consumption from housing stock."

Prices have been driven partly by demand for property to rent as an investment. Not surprisingly many people see homes as an alternative to the languishing stock market and inflexible pension plans.

Anecdotal evidence suggests lenders have become much more generous in the amounts they will lend as a multiple of borrowers' incomes. They justify this by pointing to the much lower rates borrowers pay now than a decade ago.

David Hollingworth at mortgage broker London & Country says it is not unusual for lenders to advance four times a single salary, whereas multiples of up to 3.25 have been more typical in the past.

The last few years have also brought a proliferation in flexible products that allow borrowers to increase their loans at will up to set maximum amounts. Northern Rock, for example, has a product that allows borrowers to draw down up to 125 per cent of the value of their home, up to 30 per cent of that on an unsecured basis. It argues that the extra borrowing is like taking out a personal loan to furnish a new property, but at a cheaper rate.

One concern, however, is the ease with which people can build up substantial borrowing in addition to their mortgages. Malcolm Hurlston, of the consumer credit counselling service, says: "One of the major holes in the system is that you can be paying off a minimum every month to a large number of creditors. Your record will be clear but you are getting into difficulty."

Worryingly, Hurlston says that CCCS counsellors are already dealing with clients whose incomes have been cut by reduced overtime in manufacturing, the sector of the economy that is already in trouble.

The pain could spread. Last week's rate cut took most commentators by surprise, as they thought the Bank of England would leave it alone for fear of putting more heat into the housing market and consumer spending. One way to interpret the cut is that the Bank is unconcerned about that because it knows job losses will stop consumers in their tracks later in the year.

It's time to cut up some credit cards.

How to gear up for a slowdown

• Try to pay off debt, concentrating on the most expensive loans first; store cards are still charging up to nearly 30 per cent. Consider switching to a card lender offering cheap debt transfer rates (see 'their interest', page 10), but check how long the rate lasts. Don't clock up new debt if you can avoid it, but do switch cards again if can take advantage of another introductory deal to help you repay the debt.

• If you are simply paying off the minimum amount on credit cards, look at how you can increase payments. If you cannot, take this as a sign you may already be in difficulty and may need specialist advice.

• Consider remortgaging. With rates at a 40-year low, look at locking into a low fixed-rate deal if you're on a tight budget (see page 10). Lenders are also keen to reduce the amount of discounted lending they do, so competition in the market may diminish, reducing the choice of deals later this year.

• If you have savings, consider using some to pay off debt, including mortgage debt. Even at today's low rates, the 'returns' from repaying mortgage debt are higher than on most savings accounts. This form of investment is also tax free.

• If you are moving, particularly if you are an inexperienced first-time buyer, consider carefully the extra costs you face in running and maintaining a home, in addition to the mortgage.

Consider taking a loan over a 20- ir even 15-year term, rather than the traditional 25, to repay debt more quickly. Monthly payments will be higher, but the long term savings will be substantial. If you do become stretched, most lenders will consider allowing you to extend the term for a time.