Consumers will soon owe more than their annual take-home pay, writes John McManus

By the end of this year, the average consumer will have accumulated debts in excess of their after-tax income. The passing of this inauspicious milestone follows seven years in which the growth of personal debt exceeded 20 per cent and significantly outstripped the growth in take-home pay.The main driver of this increase has been mortgage lending, but credit card spending has also played its part. The average person owed €375 on their credit card in mid-1998. This had jumped to €629 by the end of last year, according to Central Bank data.

But as a proportion of people's overall debt levels, credit card related borrowing remains small. As a percentage of after-tax income, credit card debt has risen from 1.4 per cent to 2.2 per cent over the past five years.

This rise is not out of line with the overall rise in consumer credit during the period, according Mr Rossa White, economist with Davy Stockbrokers.

However, he adds that it is hard to draw firm conclusion from available credit data, as limited information is available as to the proportion of outstanding balances that are not cleared every month.

The Irish Bankers' Federation (IBF) claims that more than half of Irish credit card users clear their bills every month and the true figure for the amount of long-term borrowing via credit cards is nearer half the Central Bank figures.

According to the IBF, the size of the average transaction done by credit card has not increased dramatically - from €72 in 1998 to €88 in 2003.

The increase in credit card borrowing has been driven by an increase in the number of cards in issue by 40 per cent and an increase in the number of transactions per card from 39 per year to 48 per year. This reflects the massive increase in the popularity of credit cards as payment instruments rather than an increasing number of people borrowing on cards.

There is something of a consensus that, while Irish consumer credit is growing at a potentially problematic rate, the contribution of the easy availability of credit cards is not a significant factor.

And, for the time being, consumer debt is still well-short of the level at which the alarm bells should start ringing at the Central Bank.

While the concept of the average worker owing more than he can earn in any one year may seem worrisome, it has to be seen in the context of people's ability to pay, says Mr White. This is best judged by looking at debt-servicing costs as a percentage of after-tax income.

This figure has also risen dramatically since 1998 - from 18.2 per cent to an estimated 29.3 per cent this year. But it, in turn, has to be judged against the 40-50 per cent level after which lenders consider customers "to be in the danger zone", says Mr White.

Irish consumer debt levels also stack up quite well compared to the UK - the economy against which most benchmarking is done.

Personal debt stands at more than 120 per cent of after-tax income in Britain. In Germany, the figure is 112 per cent and in the US it is 109 per cent.

The IBF is equally sanguine about personal debt levels, and points to research done by Central Bank economist Dr Allan Kearns, which they say also concludes that Irish consumers are not over-borrowed.

Dr Kearns analysed consumer debt from the standpoint of the size of the economy as a whole.

He predicts that personal sector credit will represent approximately 48 per cent of gross domestic product (the value in monetary terms of the goods and services produced by the economy). This compares with a euro-zone average of 50.8 per cent.

Dr Kearns also points out that the make-up of consumer borrowing has remained consistent over the past decade of economic growth.

Housing-related borrowings account for 80 per cent of personal debt, with a further 8 per cent accounted for by non-housing and 2 per cent by credit cards. These shares have remained unchanged since the early 1990s, according to Dr Kearns.

The main threat to this happy state of affairs is a sudden rise in interest rates.

Bearing this in mind, Davy Stockbrokers has estimated the impact on debt-servicing costs of a rise of 1.5 percentage points in the mortgage rate and 2 percentage points for other borrowings.

Such a move in interest rates - which is far ahead of anything that might be expected later this year - would only boost the debt-servicing ratio to 31 per cent.

The muted response of debt-servicing costs to interest rate fluctuations reflects the fact that mortgage repayments account for the bulk of most people's debt-servicing costs.

Mortgage repayments amount to around two-thirds of debt servicing. A significant proportion of this relates to capital repayments, which are independent of interest rates.

The overall picture may be healthy enough, but Davy acknowledges that, "while the average person is probably not yet under undue financial stress, this may not be the case for those at the margin".

It identifies two groups that might be as risk.

The first, and most obvious, is people who lost their jobs during the economic slowdown.

The other group is first-time buyers who may be relying on income from a rented room to meet mortgage repayments. The weakening of the rental market may pose a threat to them.

The first area in which financial stress is likely to manifest itself is credit card and other unsecured borrowing.

Recent research from the Bank of England concluded that "credit card arrears are found to respond more rapidly than mortgage arrears to shocks... consistent with anecdotal evidence that individuals tend to default on unsecured debt before secured debt".

The research also found that credit card arrears in the UK have risen steadily as overall household debt spirals. However, the figures involved are small, rising from 0.3 per cent of active credit card balances to 0.7 per cent between 1995 and 2002.

There is no comparable data available in the Republic, but the IBF says that the significant growth in credit card usage has not given rise to significant credit problems.

"Unfortunately, a small minority of card users develop debt problems," according to the IBF, which adds that it works with the Government-sponsored Money Advice and Budgeting Service to develop "appropriate debt-management solutions".