It can be difficult to find reliable information online at the best of times, but when it comes to finding reliable and trustworthy information on how to solve a debt problem, it can be a nightmare.
So, in this blog I’ll provide you with a general overview of what you need to do to get started.
What are the options?
There are several different debt solutions that can be called upon to help you regain control of your finances, and today I’ll be taking a closer look at the four most common ones.
I often refer to them non-borrowing solutions because, quite simply, they don’t require you to take on additional finance as you would through, say, a consolidation loan or a re-mortgage.
Each of these solutions has the power to help you become debt free, but each takes a very different approach from the others, across a range of varying levels of flexibility.
Logic would suggest that the more severe your debt problem, the more severe the debt solution ought to be, but this isn’t always the case.
In fact, the key to determining which is the most suitable option for you lies in you learning as much as you can about each solution and, more specifically, gaining an understanding of how each will impact your unique set of personal circumstances before you make your choice.
This way you’ll be empowered to make an informed decision as to what course of action is in your best interests, rather than being reliant on a total stranger who may not have your best interests at heart.
The four options I’ll explain in this blog are:
- Debt Relief Order – (DRO)
- Individual Voluntary Arrangement – (IVA)
- Debt Management Plan – (DMP)
The first three of these – DRO, Bankruptcy and an IVA – are formal solutions. That means they’re embedded in law and each is governed through a set of legally binding terms and conditions that must be adhered to by both you, (the debtor), and the people you owe, (your creditors).
The fourth option, the DMP, on the other hand, is an informal arrangement, meaning it has no formal terms and conditions to bind an agreement, making it a more flexible but a less powerful, option.
I’ll discuss each of these options later in the blog but, as we go through each option, remember, finding the most appropriate debt solution is all about you finding the right cleansing process to wipe out your debt, whilst protecting your assets and the things that you cherish.
Why it’s important to deal with your debt?
If you are considering one of these four options it suggests to me that you’ve recognised that you have a problem and accept that you can no longer service your unsecured debts, or at least you are close to reaching that stage.
The chances are you’ll no longer have the option of a consolidation loan available to you, or the option of juggling your balances from one credit card to another. Effectively, you’ll have run out of credit and will now be at the point where you know you have to find an alternative solution to deal with your debts.
When you’re in this situation, it can be scary. It can feel as though your debts are racing away and that everything’s out of control, so it’s a perfectly natural reaction to want to bury your head and pretend it’s not happening.
But, if you ignore the issue rather than facing it, sooner or later you’ll lose the chance to determine how you want to tackle the problem and, instead, someone will start making decisions for you.
By facing up to your situation you’ll be able to exercise a greater degree of control in how things to pan out, rather than handing that control to somebody else.
So, let’s look at the options, one by one.
Debt Relief Order (DRO)
DROs were introduced to assist people often considered to be the most financially vulnerable in our society.
Aimed, specifically, at households with little or no budget surplus and with little likelihood of any financial improvement within the 12 months period of the DRO.
What is a DRO?
A DRO is a formal debt solution that was introduced in 2008 as an alternative to Bankruptcy.
It was designed to help reduce the burden upon the Courts caused by the sheer volume of bankruptcies at the time, particularly where a lighter administrative process could be applied to less complicated insolvency cases.
The main qualifying criteria for a DRO are:
- Debts of less than £20,000.
- Affordability of less than £50 a month.
- No assets worth more than £1,000.
- No car worth more than £1,000.
- Cannot be a homeowner.
The qualifying criteria for this solution ensure only the most straightforward insolvency case qualify, i.e. those with relatively low debt, no assets or budget surplus.
The premise for the DRO is very simple – there’s a one-off application/administration fee of £90 and, assuming you qualify, you are not required to make any further payments during the term of the Order. On successful completion, any debts subject to the DRO are written-off leaving you debt free after 12 months.
We’ll be discussing DROs in more detail in future blogs.
For many people, just the thought of becoming bankrupt can instil a sense of dread or fear but, often, these feelings are based to a large extent on general misconceptions of what bankruptcy is and how it works.
But, rather than being frightened of becoming bankrupt, you should take a moment to learn as much as you can about the process and explore how it would actually affect you, personally, before you rule it out.
The truth is that Bankruptcy is a very powerful debt solution that helps tens of thousands of individuals become debt free each year and most of those will be much better off for having chosen Bankruptcy as their preferred solution.
For many, Bankruptcy will be the quickest and cheapest way to become debt free, particularly those who have little in the way of assets or those whose incomes will remain unaffected by the Bankruptcy process.
What is Bankruptcy?
Bankruptcy is a formal debt solution detailed mainly within the Insolvency Act 1986 and later updated as part of the Enterprise Act 2002.
Bankruptcy can be imposed upon you by any creditor you owe more than £5,000.
Alternatively, you can apply to make yourself bankrupt by submitting a petition online through the Government’s .gov website portal. There is an administration fee of £680 which must be paid in advance.
When you declare yourself Bankrupt, you effectively surrender control of all your financial affairs, including all your assets (the things you own) and liabilities (your debts) to the Insolvency Service, the Government’s insolvency department.
A representative called the Official Receiver (OR) is appointed to ensure you comply with all the legal requirements that your Bankruptcy Order enforces upon you, as detailed in legislation.
Will I have to make payments towards my debts?
Quite possibly, yes.
The OR will interview you as part of their duties and if they determine that you have more than a £20 budget surplus at the end of each month you will be required to pay your full budget surplus into your Bankruptcy for 3 years.
If you have no budget surplus above £20, then you will not be required to make any payments and this part of the process will have little relevance to you.
What about my assets?
All your assets will be frozen. An appointed Trustee will then decide which of your assets need to be liquidated or sold for the benefit of your creditors.
Not all assets will be considered of interest. Essential items such as clothing and general household items, a vehicle with a modest value (normally considered to be below £2,500) or tools of the trade are normally considered exempt.
But if you are a homeowner or have other financial assets then this part of the process will be of significant concern and you should seek professional advice to determine the full impact Bankruptcy could have upon you.
Of course, if you have no assets, then this part of the process will also have little relevance to you.
What about my career?
Many professionals are prohibited from going bankrupt. Those working within the financial sector, the law, the civil service, police officers, prison officers and those serving in the armed forces all face the prospects of severe sanctions or even dismissal if they become bankrupt.
It is always advisable to read the terms and conditions of your employment before you make your decision, irrespective of what career path you have, however, if you are listed above, you should also seek guidance from your professional or regulatory body.
Again, if the terms and conditions of your employment do not restrict your ability to become bankrupt, or if you are unemployed then this part of the process will have little relevance to you.
How could bankruptcy affect me long term?
Bankruptcy will impact your credit rating for a total of six years, as is the case with all formal debt solutions and, contrary to what you may be told elsewhere, shouldn’t have any more or less of an impact on your financial future than an IVA or a DRO would.
Bankruptcy is a process that is controlled by somebody else and not you, or your creditors for that matter.
Consequently, decisions will be made relating to your personal circumstances that may cause you emotional distress or hardship, particularly if you have something to lose, be it property, income or future career prospects.
If you have no assets that can be taken, or if your income will be left unaffected then, generally speaking, Bankruptcy will be the quickest and cheapest way for you to become debt free.
Individual Voluntary Arrangement (IVA)
An introduction to IVAs
Many adverts describe IVAs in a way that makes them sound like an easy option by over-simplifying what they are and how they work but, the truth is, an IVA can be quite a demanding solution.
And, when it comes down to it, the responsibility of determining whether an IVA’s in your best interests falls on you.
So, here’s a general overview of what IVAs are and how they work.
What is an IVA?
An IVA is a formal debt solution introduced as an alternative to Bankruptcy as part of the Insolvency Act 1986.
The Act states that only a licenced Insolvency Practitioner (IP) is allowed to propose and administer an IVA, which means you can’t simply undertake an IVA for yourself. If you want to apply for an IVA, you will need to engage the services of an IP to assist you.
In its most simple terms, an IVA is based around the proposal of a new ‘legally binding’ agreement, where your creditors are invited to accept payments based on what you can afford to pay each month.
An IVA normally has a fixed repayment term usually set to 5 years.
If your creditors agree to accept your IVA, they will then be legally bound to its terms and conditions, one of which obliges them to write-off whatever debt is left unpaid at the end of your agreement.
In order for your IVA to be accepted and, therefore, legally binding on your creditors, a minimum of 75 % of your creditors (in debt value terms) must agree to be bound by its terms. Once accepted, all your creditors are legally bound by the IVA, whether they voted to accept it or not.
Initially, your IP will help you through the application process and then, once the IVA is in place, their role switches to that of a kind of referee, whose job is to ensure you and your creditors keep to the terms and conditions of the new agreement.
What benefits can an IVA offer?
Firstly, entering into an IVA will immediately reduce your financial burden because the payments you make into your IVA will be based on what you can afford, rather than the contractual obligations you had before.
As I mentioned earlier, your IVA comes with terms and conditions designed to protect you and any of your assets that might otherwise have been made vulnerable should you have become bankrupt.
In most cases, protection is also extended to those professionals who would have been sanctioned under Bankruptcy, ensuring they can protect their incomes and future career prospects.
Under the terms and conditions, all creditors must refrain from taking further legal action against you for the recovery of the debts, which includes the immediate withdrawal of any bailiff action, should that be necessary.
They must also stop any late payment or interest charges being added to your debts.
And they are also forbidden from contacting you in pursuit of the debt, which means no more phone calls, letters or doorstep visits.
Finally, your creditor must write off any debt that remains unpaid on the successful completion of your IVA.
Is there anything to be aware of with an IVA?
As you might expect, IVAs come with some terms and conditions that protect your creditors interests.
Obviously, your creditors will be keen for you to repay as much of your debt as you can, so they will require that you undergo an annual budget review as part of your IVA. If you can afford to repay more, then you will be obliged to pay half of the extra amount that’s available to you.
You will also be expected to hand over any financial windfall you might receive above £500, such as insurance pay outs, an inheritance, a gift or even a lottery win. This helps your creditors recover as much of your original debt as possible, should your financial circumstances improve.
What about homeowners?
If you’re a homeowner, your IVA will contain an equity clause that details what happens to equity in your property.
In simple terms you will be expected to try and release some of the equity from your property towards the end of the IVA.
There are some very specific conditions attached to the equity clause that, in practical terms, provide you with a layer of protection by limiting your creditors’ expectations as to the extremes you must go in trying to release your equity.
If you can’t release any equity, then you may be expected to extend your IVA term for 12 months instead.
How will an IVA affect me long term?
An IVA will impact your credit rating for a total of six years, as is the case with all formal debt solutions in much the same way as Bankruptcy or a DRO would.
IVAs provide a flexible alternative to Bankruptcy for people with assets that might be lost under the Bankruptcy process and those whose incomes or career prospects could be severely damaged by being made bankrupt.
An IVA is a fixed term legally binding agreement that provides legal protection, freezes interest and charges and stops harassment by creditors.
Debt Management Plan (DMP)
A DMP is an informal arrangement, which means it comes without any legally binding terms or conditions.
It’s based around you approaching your creditors either directly or through a third party like a charity, to seek a reduction to your monthly contractual payments.
There’s no debt forgiveness and, in essence, all you’re doing with a DMP is asking for a longer period of time to repay your debts.
Unfortunately, DMPs cannot provide any legal protection or a guarantee to stop or freeze interest charges.
Most high street creditors will generally allow an initial three to six months period, allowing you time to explore your alternative options but, currently, there is no legal requirement for them to do so.
Under a DMP creditors retain the right to take action for the recovery of the debt should they so wish.
For all the reasons above, a DMP tends to be most suitable when the debt problem is expected to be short lived.
When is it best to use a DMP?
This might be due to a number of reasons, such as a redundancy, a lay-off from work, a temporary loss of income due to sick leave or any other such reason that renders you unable to maintain your debts in the short-term.
Another instance where a DMP might be favoured is when you expect an imminent change to your circumstances. Financial windfalls, such as inheritance, are often used to clear long standing debt problems that have been managed through a DMP for a number of years.
The suitability of a DMP as a method of repaying a more typical debt problem will usually be determined by the size of your debt and the amount of budget surplus you have available each month.
If you can afford to repay your total debt in a relatively short period of time, say less than 5 years, then a debt management plan can be an appealing option because it gives you the opportunity to repay your debt in a more flexible and less formal manner.
The DMP option tends to become less favourable when the repayment scheduled lengthens to beyond 6 years.
How will a DMP affect me long term?
A DMP will usually impact your credit rating for a minimum of 6 years and perhaps even longer.
If your creditors take legal action against you, any legal action will be marked on your credit report for a minimum period of 6 years from the date of that action.
As an informal solution, the DMP is generally recognised as the most flexible choice available.
It is good at dealing with short-term cash flow problems or debt problems that can be repaid within a short time frame.
No debt write-off makes it much less effective than the alternatives over the longer term.
A DMP can’t stop interest or charges being added to your debts and can’t stop creditors taking legal action against you to recover the debt.
If you want more clarity on any of these options or an impartial discussion you should speak to any FCA adviser.
At IVAorg, we are FCA-regulated advisers, so pick up the phone and give us a call on 0800 8568569 if you have any questions or would like to discuss your situation.