Solutions to debt – the UK’s ‘Top 5’

In Victorian times, unpaid debts all too often led straight to the debtor’s prison. These days, people in debt can turn to debt advisers – and a surprisingly wide range of professional debt solutions.

There’s no universal solution to debt; different circumstances demand different approaches, so the path that’s right for one person may be wrong for another. Level of debt, type of debt, income, assets, financial commitments… these are just some of the factors which must be taken into account before the right approach can be identified.

Take a look at the ‘Top 5’ debt solutions in the UK today: debt management, debt consolidation, IVAs (Individual Voluntary Arrangements), Trust Deeds and bankruptcy.

Debt Management

Talking to creditors isn’t always easy. The more creditors someone has, the harder it can get, particularly when they can’t keep up with their payments and need to ask for some leeway.

Whatever people may think about creditors, the vast majority won’t try to ‘get blood from a stone’. Rather than pursue a borrower through legal channels, they’d prefer to compromise: lowering payments, freezing interest and /or waiving charges in return for a fair and regular payment.

Borrowers can always negotiate on their own, but many ask debt management professionals to do it for them, on the grounds that they:

• Have more experience
• Understand ‘how the system works’
• Know how specific creditors tend to react, and
• Aren’t emotionally involved.

However, debt management isn’t simply a way of reducing monthly expenses. Creditors aren’t likely to grant any concessions unless they’re convinced the borrower can’t keep up with payments as originally agreed. Plus, making lower monthly payments will mean a debt takes longer to pay back and – unless creditors agree to freeze interest – cost more.

Debt consolidation

Rather than paying multiple creditors, many borrowers consolidate their debts by taking out a loan (or mortgage) big enough to pay all / most of them off. This can bring three particularly significant benefits.

First, it can lower their monthly expenditure, if they arrange to pay the money back more slowly.

Second, it can simplify their finances. They’ll have one monthly payment to make, instead of juggling various payments to different creditors at different times. Making payments late – or not at all – can cost a lot in charges, lead to legal trouble and damage their credit rating, so this is a major benefit.

Third, it can lower the interest rate they’re paying, especially if they use their consolidation loan to pay off high-interest debts like credit cards, store cards and overdrafts.

However, repaying money more slowly will mean they’ll stay in debt for longer and can end up costing them more. Plus, ‘freeing up’ credit lines like overdrafts can be dangerous – it’s easy to run up fresh debts and end up in a worse situation than before, as they’ll have to repay their new debts and the consolidation loan at the same time.

IVA (Individual Voluntary Arrangement)

An IVA, like bankruptcy, is a form of insolvency. It’s a legally binding agreement between an individual and their unsecured creditors:

• The individual agrees to make a fixed payment every month for (normally) 5 years.
• The creditors agree to freeze interest, not to take (further) legal action and to write off any outstanding debt once the IVA has been successfully completed.

Why would creditors agree to write off a portion of the debt? Often, it’s simply the best way for the individual to repay a significant portion. Since IVAs are normally only available to people whose unsecured debts total at least £15,000, creditors know that refusing to agree to an IVA might force the borrower to look into bankruptcy or unrealistic debt management plans, which could mean lower returns for them.

However, although it’s a way to avoid bankruptcy and its consequences, an IVA is no light matter – it’s a 5-year commitment which often requires homeowners to release equity so they can pay their creditors as much as possible.

Trust Deed

A Trust Deed is an alternative to bankruptcy which is only available to residents of Scotland.

It’s similar to an IVA, with two major differences. First, most Trust Deeds run for 3 years (rather than 5). Second, Trust Deeds are normally available to people with unsecured debts of £10,000 or more (not £15,000).

Bankruptcy

When someone is declared bankrupt, their assets are handed over to an Official Receiver, then sold so the money can be divided up among their creditors. When they’re discharged from bankruptcy (usually after 12 months), any debt they can’t afford to repay is written off.

The word ‘assets’ doesn’t include standard household objects, but does include valuable items such as the bankrupt’s home and (unless it’s both inexpensive and essential for work) their car.

Any creditor who is owed more than £750 can apply for the borrower to be made bankrupt (this is known as involuntary bankruptcy), but there’s also voluntary bankruptcy. Anyone can apply to be made bankrupt, and in some cases it really is the best way forward – if:

• Their debts are high
• Their income is low
• They don’t own property or other valuable assets
• Their financial situation isn’t likely to improve.

Even then, they should only look into bankruptcy if they’ve spoken to a debt adviser and discovered that none of the other debt solutions is the answer to their debt problems. Even The Insolvency Service says that “Bankruptcy should always be the last resort”.

What’s the right solution?

As mentioned earlier, there’s no single ‘silver bullet’ for debt problems. Before anyone makes up their mind about the best way of tackling their debt, it’s essential to discuss their situation with a debt expert and go through all their options in detail.