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Credit Crunch Explained

‘Credit Crunch’ has become a real buzzword over the past six months. If you have watched TV, listened to the radio or read the papers over this period, chances are you’ve been exposed to the ‘credit crunch’ phrase more than a few times.

But with ‘credit crunch’ being the latest addition to an already lengthy list of obscure acronyms and terminologies, normally formulated by people with a deep understanding of the financial market, do you really know what the credit crunch is? What effect could have on your finances? And what can you do to reduce the impact of the credit crunch on your wallet?

What is the credit crunch?

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In a nutshell, the ‘credit crunch’ is the name given to the ‘snowball effect’ financial institutions are currently experiencing due to a lack of available money across the market. As money becomes tighter, banks are not longer able to lend or borrow from one another, and as the credit crunch effect worsens, financial institutions compensate for this shortfall through their customers by increasing fees and rates on their mortgages, loans, and credit cards.

Why is there a credit crunch?

The beginnings of the credit crunch can be traced back a year ago to America, when people with a poor credit history were allowed to take out mortgages, called sub prime mortgages, which they were later unable to repay. With falling house prices and rising interest rates, these missed repayments led to a vast increase in repossession levels.

So why is the credit crunch affecting the UK?

Well, compared to borrowing from America’s central bank, the Federal Reserve, buying other banks’ loans has been a far cheaper way to borrow. Because of this, many of the US mortgages, which people with poor credit history were eventually unable to repay, were sold on to other US banks and then on to other banks and investment banks across the world. Banks in the UK bought a considerable number of these loans.

Because these so called ‘sub prime’ mortgages have been sold and resold many times over, banks simply do not know how much bad mortgage business they have bought, let alone what the impact has been on other banks. As a result, banks don’t want to lend money to each other anymore and the continuous movement of money, what bankers like to call ‘liquidity’, has dried up creating what is now known as the credit crunch.

Was Northern Rock a victim of the Credit crunch?

Yes. Northern Rock relied on borrowing money from other banks to fund around 75% of its mortgage business for customers in the UK. As the credit crunch continued, Northern Rock was forced to go cap in hand to the Bank of England for an emergency loan to help keep it afloat. Once this news of this emerged last September, it resulted in the first run on the UK bank for over 100 years, and this made the credit crunch situation worse.

How does the credit crunch affect me?

Because banks can’t lend to each other anymore the global economy has effectively started to freeze up. Stock markets across the world have become unstable - and this hurts our pension funds. Banks and building societies continue to scream out for funds - and this hurts our mortgages, credit cards and loans. It’s pretty clear that our easy credit lifestyle has come to an end.

But if that wasn’t bad enough, our everyday wallets are feeling the impact of the crunch too - prices for our food, gas, and electricity continues to rise, as does the cost of water, council tax and petrol.

And with the Government measure of inflation currently 2.5% (some 0.50% above the 2% target) and set to rise even further this year, every single one of us is feeling the pinch. However, Moneyfacts.co.uk is here to help you minimise the pain and to help you get through the difficult months ahead.

But what can I do about the credit crunch?

Unfortunately the credit crunch looks like it is here to stay for the foreseeable future. But there are many ways in which you can battle the effects, and most are easier than you would think. Take your food for example; do you really need to consume three lattes every day? Would the same sandwich you buy at lunchtime cost less if you prepare it yourself? Or if you think about how you use things around the house, does your heating need to be on all day? Could you walk rather than drive to the shop? You could also look into your outgoings. Could you be spending less by switching your energy provider? Could you be paying less if you transfer your credit card balance? Or should you think about making some serious savings with an ISA.

As you can see, individually most of the items mentioned above may not amount to much, but taking control over those small things can really make a big difference to your finances over the long term.

So, with this in mind, Moneyfacts.co.uk has prepared a couple of guides to help you beat the credit crunch on a daily and monthly basis.

What to do next:

It’s pretty clear that our ‘live for today and worry tomorrow’ spending culture is over, and now it’s up to all of us to manage our finances better. By following all, or even a just a few of our steps you’ll be in a much better position to beat the crunch. Good luck!

• Compare Car Insurance Quotes
• Switch Energy Providers
• Transfer Credit Card Balance
• Apply for a High interest Savings Account
• Credit Crunch Daily Tips
• Credit Crunch Monthly Tips