Over-indebtedness of private households: emergence, prevention and solution of a financial crisis

Over-indebtedness of private households refers to a critical financial situation of persons with such high debts, that their repayment is increasingly doubtful and they are even threatened with insolvency. This applies to debtors whose assets or current and future ability to make enough money are less than the obligations of their debts and interest. In simple terms, a person is over-indebted if he has more debt than he can repay in the foreseeable future.


Reasons for private over-indebtedness

The reasons for over-indebtedness may be deterioration of assets or a decline in income. Situations like these often arise through unemployment, short-time work, job changes, illness or divorce. Those who earn less money from one day to the next often find it difficult to manage. In this case it is necessary to adapt your lifestyle to your new financial means,  or over-indebtedness becomes a threat. This is also referred to as the common debt trap: too may expenses versus too little income.

People affected by private over-indebtedness often underestimate or fail to recognise existing risks. Time and again, debt counsellors find that those seeking help lack economic education. This results in careless management of money. Financial instruments such as consumer credit, overdraft interest and even cashless payments have a enticing effect. Anyone who does not have a good understanding of these resources succumbs to the illusion that they have more money at their disposal than they actually do. In addition to a lack of financial overview and inappropriate consumption, fraud also plays a role in some cases, where loans are obtained fraudulently with false documentation. Here, the credit institution has no way of correctly estimating the probability of default. For creditors, over-indebtedness often leads to a credit default.

Once debts have accumulated, these are often pushed aside. Through default interest and fees, the debts continue to increase until the situation eventually becomes uncontrollable. A debtor perceives strokes of fate such as unemployment, divorce or the death of the partner to play a greater role than falling into the debt trap and poor budget management. Special cases of over-indebtedness are because of failed self-employment and real estate financing.


Manageable debt burden or over-indebtedness?

When exactly does one speak of over-indebtedness? There are different definitions for it. The Federal Ministry of Family Affairs speaks of over-indebtedness if the "income over a longer period of time, after deduction of the cost of living and despite reduction of the standard of living, is not sufficient for timely debt repayment." Here the guideline is 20%: as soon as monthly debt obligations exceed 20% of the household gross income, there is an increased risk of over-indebtedness. For small and medium-sized income, some experts point out that there is already a risk from a monthly debt burden of 10%.


Over-indebtedness - what to do?

Estimates suggest that 9 to 10% of Germans are over-indebted. Anyone who is in such a position should first of all look into debt counselling from their local authority or a charitable organisation. These, together with the person concerned, will look for ways and means of remedying the situation. The first step out of over-indebtedness is to get an overview of existing obligations. Many affected people have long since lost this overview.

Debt counsellors strongly recommend a subject access request at various credit agencies. According to the Federal Data Protection Act, each consumer has the option to access the data and scores stored about him, which may also be transmitted to companies. This information is available free-of-charge once a year. Arvato Financial Solutions (in this case infoscore Consumer Data GmbH) also provides consumers the opportunity of knowing what data is stored about them.

In case of over-indebtedness, the debt counsellor helps to sort through the individual obligations and then negotiates with creditors. In many cases the gradual reduction of debt helps people handle over-indebtedness. In some cases, however, the only way is consumer insolvency. A debt settlement plan will be drawn up, which the creditors must also agree with. After a period of good conduct of 3 years, the remaining debt will be cancelled. This allows for the affected person to have a fresh start. In 2011, there were over 100,000 registered cases of personal insolvency in Germany. In the long term and as a preventive measure, good financial education is the only effective way to tackle over-indebtedness of private households.