A credit crunch is a sudden reduction in the availability of loans and other forms of lending from banks and building societies. Banks are less willing to lend out their money, and the terms and conditions for loans, mortgages and credit cards are becoming much tougher.
This took hold in 2008 due to a number of factors. One of the most prominent was the state of the housing market in the US. Increasingly US mortgage holders have been unable to keep up with their repayments, and US banks have suffered as a consequence. This has affected the UK because many high street banks invested in the American banking system, by buying these loans. These are now worth less than the bank invested – hence the banks have not profited from their investment. Add this scenario to the problems faced by the fallout of Northern Rock in 2007, the collapse of the Icelandic financial markets, and the problem becomes evident.
Impact of the Credit Crunch
Borrowing is becoming more difficult with the rates increasing drastically in relation to credit cards, mortgages and loans. It is particularly tough to get a mortgage as banks don’t want to take any customers with a poor credit rating.
Credit Cards
As the credit crunch and recession accelerate in 2009, there is a fear that consumers will be issued with lower credit limits on their cards. This not only means lower spending limits for customers, but if they are trying to balance transfer to clear their debt they may be unable to do so. It will also mean that it will be difficult for those with less-than-perfect credit ratings to get the best deals.
The Bank of England cut interest rates in early 2008 to encourage spending, but there is no guarantee how long this reduction will last. Falling interest rates do not directly impact credit card interest rates but they do impact banks' ability to lend, making them fussier in terms of who they give credit cards to.
18, 000 credit card applications are being rejected daily in the UK, with 3.24 million applications having been rejected in the past six months. One in ten applications from the 25-32 age group has been rejected.
To minimise the effect this has on your spending, credit cards should only be used for their main purpose (i.e: not making purchases on a balance transfer card).
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Loans
As the credit crunch accelerates, it is estimated that the interest rate on loans will increase, even though interest rates have fallen. The smallest loans have been the worst hit – on average rates of 14.4% have increased to 18.9%.
Banks are now concentrating on getting their money back into the bank and are becoming much more tightfisted when it comes to lending money. It is therefore harder for you to find a lender, and when you do the rate will be higher than a year ago.
Moneysupermarket.com has a loan comparison section allowing you to see the best loans on the market. Consider your own bank for loans - they will be aware of your credit history and your savings, credit and borrowing patterns.
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Mortgages
The value of property has been affected by the credit crunch with an estimated 95.1% of house prices falling in April 2008. Banks are unwilling to provide as high mortgages as they have been doing. Therefore potential buyers have less available money, and sellers have to accept a lower price, meaning house prices have been falling. The high number of different mortgage offerings which were once available from the numerous UK lenders has also been reduced.
As the credit crunch accelerates the need for a mortgage deposit has increased with banks offering the best deals to customers who have deposits of 10% or more.
When buying a home a deposit can be beneficial in two ways:
- Demonstrates financial commitment to the lender
- Reduces the amount you need to borrow, which can result in cheaper borrowing rates
A higher lending fee can be charged when you are seeking to borrow more than 75% of the home’s value. The UKs biggest mortgage lender HBOS, who has 20% of mortgage market), has increased the interest rates for borrowers who have less than a 25% deposit.
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Savings
The widespread credit crunch cannot stop the savings war as banks battle it out to take your money. An increasing number of foreign banks are entering the UK market with high interest rates providing a stark contrast to the so-called homegrown banks and the poor comparative rates which they offer. The savings section provides recommendations of the top offerings which are currently available.
UK Banks
The risk of a UK bank collapsing is low but the credit crunch has turned the traditional logic on its head. All regulated financial organisations are protected. The first £35,000 saved in an institution is protected. Note that any debts you have with the bank will be deducted from your savings prior to you being able to reclaim your investment.
You may be unable to withdraw or access your cash if the bank runs into problems. Stick with the protected cash level of £35, 000 to ensure you don’t run into any financial problems.
The Treasury stated in May 2008 that in the event of any bank running into difficulties it has £4billion which it can immediately call on. However, this fund would only cover the UK's 26th biggest bank collapsing – and does not even begin to cover the funds which would be needed if the big high street banks were to collapse.
Foreign Banks
A high number of foreign banks have entered the UK market. These banks can offer such high rates as they are not based in the UK and thus the recent credit crunch and consequent implications have no effect on their offerings.
Most of the foreign banks mentioned in the savings section - is Kaupthing, FirstSave and ICICI are regulated by the Financial Services Authority.
The four key foreign banks are FSA regulated and all comply with the voluntary banking code, meaning that the first £35,000 of any investment is guaranteed in the event that anything would happen to the bank and your money. If you are unsure of a bank's credibility, or don’t recognize the bank's name, fsa.gov.uk has information on all banks and details unauthorized bank accounts.
Not all foreign banks are regulated by Financial Services, so if anything was to happen to the bank, there is a risk that you could lose all of your savings.
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Tips During the Credit Crunch
Paying into Regular Savings
It is more important than ever to have a cash cushion to rely on in the light of a credit crunch. Experts suggest three months' salary.
Life Insurance
Life insurance is essential if you own your own home and have a family. If you live alone, or are in rented accommodation, it could potentially be cancelled to save you money.
Pension
When money is tight it can be tempting to stop paying into your pension in order to save money, but pensions are passed on the notion of compound interest – leaving the money away for a long period of time to gain interest. Thus even paying in the bare minimum is essential for a healthy pension fund on retirement.
Holidays
Cancelling a pre-booked holiday can incur a fee. Avoid doing so if at all possible. The era of cheap flights could be coming to an end as the cost of fuel continues to rise. Already noticeable charges exist for luggage, airport check-in and even onboard food.
Social Life
Shopping, eating out and buying non-essentials are the key areas which are being reduced in light of the credit crunch. The price of basic food items such as bread, cheese, pasta and rice have continued to rise - see below for more details. See the food section for more information on how to keep the cost of food down. Clothes retailers are also affected as consumers are less willing and able to buy non-essentials and stores must reflect this in their prices and stock.
Food /Increased Cost%
Eggs/47%
Salted Butter/62%
Cheddar/25%
Rice/60%
Pork/7%
Bread/5%
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