5.1 Estimating the extent of problem debt

Clearly for many individuals and families, a substantial level of debt is not necessarily a cause for concern. As shown in Figures 12 and 13, debt levels vary markedly with the stage of the life cycle. Whether or not this is regarded as “problem debt” will depend in large part on the income available for debt servicing. If the cost of servicing debt is within a family's available income after meeting basic living costs, we would not consider this family to have problem debt.

Ideally, we would have been able to identify those respondents who had problem debt by comparing expenditure on debt servicing with income after basic living expenses. However, as SoFIE does not collect data on expenditure, we estimated debt servicing costs from data on liabilities and used this to construct a ratio of debt servicing to income, which we used for our problem debt classification. In most of our analyses, family units with debt servicing costs in excess of 30% of their gross income were classified as having problem debt. In selected tables, 40% has also been used. While these are arbitrary cut-offs, they help to identify families that could potentially have had trouble servicing their reported levels of debt or could have easily fallen into this category if they were they hit by an unexpected increase in interest rates or a sudden decrease in income. As families with higher incomes tend to be able to cope with both higher debt servicing costs and higher debt servicing costs relative to income, we repeated some analyses for those in the lower half of the equivalised income distribution.

We estimated the cost of servicing debt from reported debt levels and assumptions about the cost of different types of debt. We applied the following assumptions to broad debt categories: 7.4% has been applied to mortgage debt (only the interest component is included in the estimate of debt servicing costs); student loan debt servicing is calculated as 10% of an individual's earnings above $15,964 (rate and earnings thresholds consistent with 2004 legislation); 10% was applied to bank overdrafts; and 20% was applied to all other personal liabilities such as hire purchase and credit card debt. A debt servicing to income ratio was calculated at the family unit level by dividing our estimate of debt servicing costs by total income reported (from all sources before tax).

An important caveat is that the interest rates listed above have been assumed to apply to all non-partnered individuals and couples who hold that particular type of debt. For example, all those who had hire purchase and credit card debt are assumed to have paid the same rate of interest. To the extent that interest rates varied across individuals, debt servicing costs will have differed from those we estimated. If the errors are non-random with respect to debt levels and/or income, our estimates of the proportion of families with problem debt may be biased.[34]

Table 10 contains summary statistics for debt servicing costs as a percentage of income for non-partnered individuals and couples in 2003/04. All means, medians and percentages in this table are conditional on having debt servicing costs and positive reported income.

The mean debt servicing as a percentage of income for non-partnered individuals is estimated to have been 15.8% in 2003/04. The 95% confidence limits were 10.4% and 21.1%. This average was raised by a few highly indebted individuals, such that the median was much lower at 3.6%. In other words, of all non-partnered individuals with positive income and debt servicing costs in 2003/04, half were estimated to have had debt servicing obligations at or below 3.6% of their income. About 6.2% of singles with debt servicing costs and positive reported income were estimated to have had debt servicing percentages over 30%.

Non-partnered individuals in the lower half of the equivalised income distribution had an average debt servicing percentage of 21.8%. For this group, the upper 95% confidence limit for the mean is only slightly below our problem debt threshold of 30%. This means there is insufficient evidence to reject that the true average for debt servicing costs as a percentage of income for non-partnered individuals in the lower half of the equivalised income distribution was 29%. However, the distribution for this group was even more skewed than the distribution for the full sample of non-partnered individuals and so the median is a better measure of central tendency; here the median was only 2.7%. Some 7.6% of this low-income subgroup had debt servicing percentages above 30%.

For couples, average debt servicing as a percentage of income was estimated to be 14.3%, which was insignificantly different than that for non-partnered individuals. However, the median appears to be notably higher at 6.8% compared with 3.6% for non-partnered individuals. The percentage with debt servicing costs exceeding 30% of income was also higher, at 8.1% compared with 6.2%. Restricting the sample to those couples who had equivalised income below the median resulted in a distribution that was more skewed, with average debt servicing as a percentage of income increasing to 20.1%, and the median reducing slightly to 5.5%. The percentage with debt servicing costs exceeding 30% of income increased to 12.1%.

¹ Complete results are given in Appendix Tables A.3 and A.4.

² The estimates of the ratio of debt servicing to gross income applies to those individuals and couples who were estimated to have debt servicing costs and who have recoded income that is positive. This is the sample used for the debt servicing ratio regression models (see footnote 40).

Source : SoFIE wave 2, Statistics New Zealand; the Treasury

Figures 14 and 15 present the distributions of the debt servicing ratio implied by the SoFIE sample for 2003/04 using a logarithmic scale.[35] However, for ease of interpretation, the summary statistics (M=mean and p50=median) marked on the plots relate to the untransformed distribution. The vertical line indicates the 30% cut-off, so those lying to the right had debt servicing obligations that exceeded 30% of their gross income. These distributions are conditional on positive reported income and positive debt servicing costs.

The most striking feature of Figure 14 is the modest proportion of those who had debt servicing exceeding 30% of income. Figure 15 displays the distribution for those families whose equivalised income fell below the median. Here the share of couples paying more than 30% increased to around 12%.

Figure 14 - Distribution of log debt servicing to gross income ratios for non-partnered individuals and couples

Source: SoFIE wave 2, Statistics New Zealand; the Treasury

Figure 15 - Distribution of log debt servicing to gross income ratios for non-partnered individuals and couples with incomes below the median income

Source: SoFIE wave 2, Statistics New Zealand; the Treasury

More detailed descriptive statistics for debt servicing ratios and the percentages that had debt servicing costs exceeding 30% of income are given in Appendix Tables A.3 and A.4. Note that these statistics are purely descriptive and they relate to the year ended September 2004. For non-partnered individuals, groups that had relatively high median ratios and relatively high percentages with debt servicing exceeding 30% of income were characterised by: low income; high assets; middle age; sole parents; degree-holders; those living in Auckland or Waikato; home owners; employed; maximum source of income from “other” (ie, not from earnings or government); divorced or separated. A relatively high median ratio did not always coincide with a higher percentage with debt servicing costs over 30% of income. For instance, although median ratios were also relatively high in the top equivalised income deciles, debt servicing costs exceeded 30% for a relatively small share of individuals. For example, deciles 7 to 10 had higher median ratios than decile 1 but the percentage with debt servicing costs exceeding 30% of income was considerably lower (only 4.5% for deciles 7 to 10 compared with 22% for decile 1). Further, these percentages may overestimate the number of individuals with high equivalised incomes who had problem debt. As noted earlier in this section, those with relatively high incomes are more likely to be able to cope with higher debt servicing ratios and using a cut-off of 30% of income may be inappropriately low.

For couples, the groups that tended to have relatively high median debt servicing ratios and relatively large shares paying more than 30% of their income in debt servicing were typically characterised by: low to middle income; high assets; middle age; ethnicities other than European or Maori/Pacific; migrants; having dependent children; educated; and being home owners. Again, couples with relatively high equivalised incomes tended to have relatively high median levels of debt servicing in relation to income, but the share where this percentage exceeded 30% was relatively low (6.5% for those above the median compared with 34% for those in decile 1).