Introduction
Our definitions
In this report we define debt as any financial obligation, leveraged against an asset (secured debt) or against future income (unsecured debt). For our purposes, debt includes mortgages, student loans, bank loans, hire purchase, credit cards, store credit, being in arrears and use of fringe lenders. Indebtedness refers to the act or situation of being in debt. Over-indebtedness refers to the act or situation of being in ‘too much’ debt (also referred to as ‘problem debt’). In practice this can be difficult to measure because debt repayments may be prioritised over other expenditure items (even necessities). Further explanations are provided in the Definitions section.We define saving as the process of putting money aside. Saving (singular) is a flow-concept and should be distinguished from savings (plural), which is another term for wealth (assets net of liabilities). However, we recognise that there are two valid approaches to measuring saving: measuring the difference between what people earn and spend in a given period (the ‘flow’ approach) and measuring the difference between people’s wealth over two periods (the ‘stock’ approach). These approaches can lead to different results if wealth changes as a result of a rise or fall in the price of assets, which would be picked up by the stock approach but not necessarily by the flow approach.
We are primarily interested in the population of New Zealand families who use debt, although there are practical issues with defining ‘family’ the way we would like. For the purposes of this report, ‘family’ has been defined as a single individual with or without dependent children (‘single families’) or two individuals in a social-marital relationship with or without dependent children (‘couple families’). Under this definition, multiple families may be living in one household or a single family may be living across more than one household – family has not been defined by living arrangement. We consider that this definition of family by relationship best captures key financial interdependencies in families and is best suited to available data sources. We acknowledge, however, that this definition is narrow and excludes finance-sharing arrangements among family members that may be quite common, such as between parents and non-dependent or adult children, siblings and children and grandparents.
Our approach: the theory of saving
Understanding families’ decisions to take on debt is difficult, as such decisions are likely to be based on different levels of financial knowledge and security as well as experience and comfort with risk and debt. Families’ decisions are also likely to be influenced by the types of debt available, when and how the debt is to be repaid and potentially conflicting financial needs.The theory of saving provides a simple framework for thinking about why and how families use debt: debt is a means of bringing consumption or investment forward. The concept of indebtedness generally carries negative connotations but, in reality, indebtedness has become an increasingly important mechanism for families to smooth their income and effectively insure against unforeseen events.
Figure 1 illustrates how we apply the theory of saving to the issue of indebtedness. The inner ovals represent the different populations of families we are interested in, and the two large overlapping circles represent the potential variables (many of which are suggested by savings theory) that may help distinguish the two population groups. A shortcoming of this diagram is that it does not capture the dynamic way in which people may use debt.
Figure 1: Factors that may influence debt behaviour
There may be some important differences between circumstances and behaviours to help us distinguish:
- non-debtors and debtors
- those who use debt well and those who get into difficulties
- temporary from recurrent and long-term debtors (such as those who pay off credit cards on time and those who do not).
Our working assumption: circumstances, behaviour and luck interact to determine debt decision-making and outcomes.
In addition to gauging the scale and distribution of private debt amongst New Zealand families, this report examines international theory and evidence on the role that circumstances and behaviour (and the relationship between them) play in explaining why some families use debt better than others. Luck (or unanticipated events) can also be a factor in families’ financial fortunes.
Figure 2 illustrates several pathways that different New Zealand families may take (note that the ordering of the columns is illustrative only). The diagram suggests that even if one’s financial behaviour is prudent, poor circumstances and poor luck can mean ending up with problem debt. By the same token, good circumstances and good luck may forgive poor financial decision-making.
Figure 2: How factors may influence pathways to problem debt
Our structure
This report is organised as follows:Part 1 outlines some basic facts about New Zealand families’ indebtedness – how many families are in debt, what type of debt do they have and what is the average size of that debt?
Part 2 outlines the theory and evidence about the impact of circumstances on families’ indebtedness.
Part 3 outlines the theory and evidence about the impact of behaviour on families’ indebtedness.
Part 4 pulls together what we know about the way circumstances and behaviour interact to distinguish those who manage debt well, and those who do not – and thus to understand who is vulnerable to problem debt. This part does not attempt to measure problem debt or identify those in or close to problem debt. Rather, it attempts to define problem debt for measurement purposes, provide data or evidence and present hypotheses that are worth testing with future research.