Day of reckoning may be approaching soon for a nation up to its ears in debt

A nation of home owners mortgaged to the hilt; property prices poised on the brink of possible collapse; unflappable consumers continuing to pile up debts on their credit cards as if there was no tomorrow.

Sound familiar? Memories of the late 1980s and early 1990s will be revived today by a harsh warning by the Financial Services Authority, Britain's chief financial watchdog, that families are burdening themselves with far too much debt at a time of economic uncertainty, a stagnant stock market, rising taxes and the threat of war in Iraq.

In a document that sets out its concerns for the year ahead, the FSA says consumers are stretching their finances to the limit.

It is growing increasingly concerned that unless people stop borrowing at what it says is an unsustainable rate, then there will be a "rapid and disorderly" correction.

In other words if, as a nation, we carry on loading ourselves with loans then we could – and the FSA stresses it is a fear not a forecast – find ourselves drowning in debt.

Those who recall the previous recession will be aware of the misery that ensued when the housing bubble burst and millions found themselves in "negative equity" – saddled with a house worth less than the mortgage.

The FSA says the stress signs are evident. It published research showing that six million of the 30 million families in Britain are finding at least moderate problems meeting their interest payments.

The figures certainly appear terrifying. Outstanding mortgage loans now total £665bn, or two thirds of the entire output of the UK economy, while other unpaid debts stand at £155bn.

In the 12 months to November mortgage borrowing increased by 13 per cent while consumer credit rose 15.4 per cent. Inflation, by contrast, was only 2.6 per cent; wages rose 3.8 per cent.

Figures released yesterday revealed little sign of a slowdown, with new mortgage lending hitting a record of £219bn last year, the Council of Mortgage Lenders said.

And with house prices rising by 25 per cent a year, home owners have rushed to cash in by taking out fresh loans against their homes at a pace not seen since the late 1980s. "These levels and rates of growth have important implications for the UK economy and also represent a direct risk to consumers," the FSA said.

It declined to say how likely a consumer debt crisis was but there were strong hints that the regulator was growing increasingly worried.

Carol Sergeant, the FSA's managing director, said: "Borrowing by consumers has been growing at an unsustainable rate. There are considerable uncertainties and plenty of reasons for caution at a time when consumers look financial ly stretched. There is a risk that when a correction comes, it could be rapid and disorderly."

The FSA document, Financial Risk Outlook 2003, highlighted a host of risks associated with the economic outlook and depressed conditions in financial markets.

The FSA said that not all consumers or businesses had fully grasped the implications of the brave new world of low inflation, low interest rates and low stock market earnings when making savings and investment decisions.

Low inflation means that while interest and mortgage rates are low, cutting the monthly bill, the outstanding debt will not be whittled away by inflation as it was in the 1970s and 1980s. Likewise, wages will not rise much above inflation and stock markets, which have slumped in the past three years, are unlikely to produce the high returns of previous decades.

This debt mountain is creating a big headache for the Bank of England, which is hoping consumers will rein in their borrowing slowly. Yesterday Sir Edward George, its governor, said he doubted consumers would "fall off a cliff" and attacked those forecasting a crash, dubbing them "gloomsters".

This message wins support from the lending industry, which believes its members are lending responsibly.

David Dooks, the head of statistics for the British Bankers' Association, said there had been no relaxation in the tests banks use before approving a loan. "You should look at the affordability of carrying the debt rather than the levels," he said. "The evidence from our members is that the cases that are referred [to advice groups] are because of a change in circumstances rather than because they overextended themselves."

The view is backed up by figures on affordability. Thanks to the lowest mortgage rates for a half a century, home owners use less than a third of their income to pay the mortgage compared with three quarters at the peak of the last boom.

Saxon Brettell, a housing expert and executive director at Cambridge Econometrics, agreed with the FSA that the current state of affairs could not continue. "We are looking at unsustainable debt driven by a speculative housing boom," he said.

But he doubted there would be a crash without a shock such as the doubling of interest rates that happened in the late 1980s or a huge surge in unemployment. "We don't see either of these happening," he said. "It is still a pretty positive outlook for consumers in the UK."

But some forecasters – probably the very people that Sir Edward would deem "gloomsters" – believe there is no need for a particular trigger.

Capital Economics, a consultancy headed by Roger Bootle who hit the headlines in the 1990s by forecasting an era of low inflation, believes property prices will rise 20 per cent this year, then fall 5 per cent next year, followed by annual drops of 10 and 7 per cent. Sabina Kalyan, a property analyst at the firm, said there did not need to be a trigger for the market to slow. "All it would take is for households to be unwilling to pay the price asked for housing, even if they were still able to afford it," she said. "This is pretty much what happened when the equity market bubble burst in the US in 2000."

But even if the housing market is safe, there is still a worry over households' mountain of unsecured debt – credit cards, store cards, overdrafts and street loans.

More than half of those worried about meeting their debt payments – about 3.2 million families – were struggling to pay non-mortgage loans.

On average the value of their loan was greater than all their liquid assets – a form of personal negative equity. The FSA said some of these people were vulnerable to loan sharks. "Lack of awareness of the risks associated with predatory lending such as extortionate interest rates is a concern for us," it said.

I was offered £6,850 credit in one day

By Terri Judd

Ben Dunnell was shocked to learn that in one day alone he could spend more than a third of his annual salary.

The 24-year-old parliamentary researcher travelled the length of Oxford Street asking about store-card applications. He found seven well-known high street chains willing to give him a total of £6,850 to spend on that very day.

Mr Dunnell earns £18,000. Having graduated from Sheffield University in June 2001, he is paying off student debts of several thousand pounds. In his words, he has to be "pretty careful" with money, yet one of the stores was willing to offer him £2,000 in one day.

"The worst thing is that the interest rates are appallingly high. Someone who did not know the full significance of what they were doing would think they were getting a good deal with all the offers such as holiday vouchers," he said.

One card had an APR of 30.9 per cent, Mr Dunnell said. He worked out that if he had made minimum payments only on another, he would have run up interest payments of £451 in 12 months.

Mr Dunnell, who was researching for the Liberal Democrats, acknowledged his applications were based on the assumption that he had a perfect credit rating. Furthermore, safeguards are set up that would probably set off alarms after he had made several applications in such a short space of time.

Nevertheless, he said, the very fact that someone on his salary could get thousands of pounds of credit in one day was frightening.

Official guide to beating debt

Do your budget: Calculate how much you can afford each week to pay off debts. Give priority to some debts: angry banks, your bookie, the kids' piggy banks, etc.

Contact everyone you owe money to as soon as possible:

Explain the problem and how you intend to pay. The phrase "the cheque's in the post'' doesn't really cut the mustard any more.

Repay debt at a rate you can afford, even if it's only a small amount: Companies know that courts will make such orders, so have little to gain by taking you to court at further expense to them. Offering 50p a week for a £10,000 debt is, though, not really playing the game.

Avoid taking on any more debt:

Look for ways to cut unnecessary spending, like giving up that Imelda Marcos shoe fetish or Michael Owen-style gambling. Then you'll be in a more positive mindset to look for a better-paid job.

Switch to a basic bank account: One that won't let you have a nice, big overdraft. Look at moving mortgages or credit-card debts to low or zero-interest deals, which are advertised widely.

Don't struggle alone: Organisations such as the Citizens' Advice Bureaux and the Consumer Credit Counselling Service can help you. Your local branch of the Cosa Nostra or those nice people offering new loans to those already up to their knees in County Court judgments can't.

Based on FSA guidelines