On Tuesday Jan 30th 2007, the Financial Times quoted Adam Applegarth, Northern Rock’s chief executive as saying that in 9 out of 10 cases, IVAs are not in the best interests of consumers as credit ratings will be ruined.
I find this a very strange comment. My reason is that the only people who can go into an IVA are those who are truly insolvent. By very definition, someone who is insolvent is not in a position to repay their debt. If you can not repay your debt, then you only have three choices, do nothing, continue to borrow and make matters worse or deal with your debt head on using either a Debt Management Plan (DMP), IVA or Bankruptcy procedure.
Clearly doing nothing will not solve the problem. Equally, best advise is NOT to continue borrowing. If you already know that you can not afford to repay what you owe, then you should certainly not be borrowing more! As such, you are going to have to use one of the three debt solutions DMP, IVA or Bankruptcy . It is a simple fact that using ANY of these solutions will ruin your credit rating. For example:
Debt Management Plan – Creditors will issue default notices against you which will be recorded on your credit file. These will prevent you from borrowing until the account is settled in full which may take many years.
IVA & Bankruptcy – A notice of the procedure will be added to your account which will prevent you from borrowing until the procedure is completed and the debts satisfied. The notice will remain on your file for 6 years.
Given the above, I believe it is totally wrong to infer that undertaking an IVA will make your credit rating any worse than any of the other options open to you if you are insolvent.
Note, please see my blog of the 23rd Jan 07 for more info about what happens to your credit rating post IVA
If you enter into an an IVA, this is registered on your credit file. Normally, an IVA will last for a maximum of 5 years. After the IVA is completed, your debts are then called “Satisfied”. You will receive a certificate of satisfaction from your insolvency Practitioner. The record of your IVA will continue to remain on your credit file for 1 additional year (a total of 6 years from the first day of the IVA). This means that if your IVA runs for only 4 years, the record on your credit file will remain for a further 2 years.
While your IVA is running, you must not take any credit without the prior knowledge and agreement of your insolvency practitioner. It is most unlikely that your IP will agree to you taking credit unless this is for the benefit of your creditors (for example re-mortgaging your house to release a lump sum for your creditors). If your IP does agree that you can take credit, you should be aware that your credit rating will have been effected by your IVA and so you will probably have to get specialist lending advice.
After your IVA is completed, the record of your IVA will remain on your credit file for 6 years from the date your IVA was accepted. This means that it is possible that you will continue to be refused credit until this time has passed. In order to minimise the problems, once your IVA is finished, you should send a copy of your certificate of satisfaction to both of the credit agencies (Experian and Equifax). They will then mark against the IVA record that it has been satisfied. It will then be down to the individual lender to decide whether they want to lend to you or not. Generally, you will be able to take a mortgage with little problem. However, you might have to get advice from a specialist broker and you might not bet the best interest rates on the high street although competitive rates are generally available.Your credit file will only truly be back to normal after 6 years when the record is taken off the file completely. This will happen automatically.
This may all sound like doom and gloom. However, remember, although you will be living on a tight budget while you are in an IVA, after it has completed you will be able to keep 100% of your disposable income. Instead of buying the things you want on credit, you will be used to living without your disposable income and so you could then start saving to buy the things you want for cash!
If you are made redundant from your job, the first thing you must do is let your IP know. Its is likely that they will be able to suspend your monthly IVA payments and give you a payment holiday. This will give you a breathing space while you find a new job. Generally your IP will be able to give you up to 2-3 months break without a great problem.
Once you get a new job, there are three scenarios:
1 – I found a new job on the same money
This is the ideal scenario. It means that you should be able to start making the same IVA payments again without a problem. All that happens is that the months you have missed will be added to the end of your IVA. In effect, you will make the same number of IVA payments but the ones you missed in the middle will be added to the end.
2 – I found a new job but with less money
If this happens, then the only way you are likely to be able to continue with your IVA is if your payments are reduced. To achieve this, your IP will have to propose a variation of your IVA to your creditors. As long as the variation and reasons for it are reasonable, then very often the creditors will accept the change even if this means that their dividend is reduced. They may of course ask for some additional payments to be added onto the end of your IVA to compensate.
3 – I found a new job on more money
If this happens, then you will be able to restart your IVA payments, but you might be asked to increase them. You will not necessarily be asked to hand over the whole of the increase. The additional amount you pay will depend on other factors such as whether as a result of the new job, your have any additional monthly expenses (eg additional travel costs).
What happens if I can not find a new Job
If you are made redundant and just can not find alternative work, or loose your job through medical reasons preventing you form working again, then payments to your IVA will clearly have to stop. What happens next will very much depend on your financial situation and how long you have been in your IVA.
For example, if you are given a lump sum as a redundancy package, your IP may well be able to negotiate a full and final settlement of your IVA using some or all of the lump sum. If you do not receive a lump sum but have already paid a significant number of your IVA payments, your IP may be able to agree with your Creditors that the IVA should be settled early based on what you have paid to date as they are unlikely to ever receive any additional payments.
The worst case scenario is that you can not find new employment, you have no lump sum and your creditors will not agree to settle early. In this situation, unfortunately it is likely that your IVA will fail. You amount you owe will then revert to the original sum outstanding before the IVA was introduced. At this point, your IP may decide to declare you bankrupt. If not, you will need to decide whether you want to do this yourself or consider a Debt Management Plan.
This is a question that I am often asked and it is certainly an interesting topic.
If someone’s sole income is derived from benefits then there is no legal reason why they should not be allowed to propose an IVA. If after prudent budgeting, a review ofreasonable expenditures shows that there is a disposable income available, then this could be used as the basis of an IVA proposal.
Despite this situation, an IVA can only be put in place if the proposal is accepted by creditors. Over the past 12-18 months, many commercial banks have taken the view that it is not morally correct for someone who’s sole income is benefits to carry out an IVA. Their argument is that benefits are means tested and designed to pay for a reasonable cost of living but do not include extra funds for the repayment of debt.
On the face of it, this is a reasonable argument. However, it seems to me that if someone with this type of income has been allowed to borrow in the first place and then gets themselves into difficulties, then surely they should be given the same options as everyone else to resolve the problem. After all, if not IVA, then what? A Debt Management Plan will require monthly payments in the same way as an IVA and so surely if your argument is that benefits money must not be used to pay for debt, then the Debt Management plan is also taboo. This then leads us to assume that those on benefits will be driven to declaring bankruptcy which is surely in no-one’s interest.
My personal view is that IVAs for people who’s sole income is benefits should not be dismissed. However, the discussion is likely to continue.
Note – It is certainly possible for someone to undertake an IVA when only part of their income is derived from benefits (eg a tax credit). Also creditors may consider accepting an IVA if the debtor has a property which they stand to loose in bankruptcy.
Today I have been speaking to someone who has been in an IVA for 2 years. When they started their IVA they were single and owned a flat with some equity. As with many similar IVAs, there was a clause included that stated any available equity from the property would have to be released for the benefit of the creditors in the 4th year of the IVA.
Unfortuanately this person says that they were not aware of this clause. During the last two years, they met a new partner who also had a property. They decided to sell both their properties and combine the proceeds to buy one larger house. They did this without the knowledge or consent of the person’s IP. This has caused huge problems. It turns out that the person had £20,000 of equity in the property which was released and put into the new home. The new mortgage is such that it can not be changed for 5 years. The creditors are now taking the view that the release of this equity has broken the IVA agreement and if £20,000 is not made available the agreement will fail.
This helps illistrate that if you are in an IVA, you must ensure you understand its terms and conditions. Do not change or take on a mortgage without the prior knowledge and concent of your IP. It could have dire consequenses
If you are suffering with a debt problem, there are a number of different things you can consider. I am going to describe them briefly here and expand upon them later.
If you have a poor credit history, getting an unsecured loan at a reasonable rate of interest will be difficult. You should think very carefully about whether borrowing more money to solve your debt problem. You may be able to consolidate multiple monthly payments into one, but can you afford the single new loan repayment? If not, all that will happen is that you will continue to supplement your income with your credit cards and the balances will increase again.
1. Consolidation
On the face of it, consolidation seems like a good idea. It may be possible for you to consolidate multiple debts with one larger loan - either unsecured or secured perhaps through are-mortgage. However, consolidation must come with a health warning. In my experience, 9 times out of 10, consolidation will not solve a serious debt problem. This is for two reasons: Firstly, you consolidate but then do not change your spending habits. This means that after 18 months or so, the balances on your cards (which you consolidated in the first place) are creeping up again and before you know it you have the consolidation loan payments and new card payments on top and you are back where you started but with twice as much debt.
Secondly, most people go head long into consolidation because the temptation of reduced monthly payments is very strong. However, if you can’t afford even the reduced monthly payment, then you will continue to use your cards and overdraft to supplement your income. Before you know it, you are back in the same situation again. But this time its 10 times worse because you have the loan as well.
2. Debt Management Plan or Informal Repayment Plan
Where your debt is typically less than £15,000, a sensible option might be to consider a Debt Management plan. This is an agreement with each of your creditors to reduce the amount you pay to each of them to fit within a budget you can afford. The advantage of this is that you start to repay your creditors in a sensible managed way and stop making things worse by robbing Peter to pay Paul.
Although on the face of it, this solution sounds good, there are some significant drawbacks. Firstly because you still have to pay 100% of your debt back, it is likely to take you much longer to repay your debts than would otherwise have been the case. Also, the solution is not legally binding. Therefore there is no guarantee that further interest charges will be frozen. It is also possible that your creditors may continue to take further action against you such as an application for a County Court Judgement or Charging Order against your property.
I would suggest that a Debt Management plan is best used if you need a breathing space from your crediors. If you know that your financial situation is going to improve in the next 6 months or so then the Debt Management Plan may be just the job. However, if you do not expect your circumstances to improve, a Debt management plan will not offer any light at the end of the tunnel.
3. IVA - Individual Voluntary Arrangement
Where your total debt exceeds £15,000, you may be able to consider an IVA (Individual Voluntary Arrangement). This is a formal, legally binding way of dealing with your debt. It allows you to make an offer to settle your debts with your creditors over a 5 year period (no longer than a standard unsecured loan). Further interest and charges are frozen by law and you make just one monthly payment based on what you can afford. At the end of 5 years, whatever debt is outstanding will be written off legally thus leaving you debt free to turn over a new leaf.
In order to undertake an IVA, you must be able to make a minimum monthly payment to your creditors of c£250. This may be reduced if you are a homeowner and you can release some equity as part of the deal. Releasing equity may not be a very palatable proposition but at least having done this within the legal framework of an IVA, you know that your debts will be totally gone. You also retain full control of your property which is certainly not the case for the final option below.
4. Bankruptcy
If you have no income in order to make any kind of monthly payment to your creditors and no definite view as to when this might change, then the only way you can solve your debt problem for good is to declare Bankruptcy. In doing this, the Court will take away from you the responsibility of paying your debts. You will normally be bankrupt for 12 months. After this time, any unpaid debt will be written off and you will be able to turn over a new leaf, debt free.
You will not necessarily get away with paying nothing! If you can afford to do so, the court will ensure that you make payments towards your debt for up to 3 years. This is called an Income Payment Order.
If you rent your property and have no valuable assets (e.g. an expensive car) it is very unlikely that the Court will require you to give up any of your goods. However, if you own a house, then the Court has the right to take this from you and sell it for the benefit of the creditors. If you are a property owner, you must ensure you take further advice before deciding to declare yourself bankrupt!
There are two questions that I am asked more than any others, how do people get into debt and who’s to blaim. This blog looks at the Who’s to Blaim question.
Is the individual to blaim? I once heard a comment from someone who was overweight. They said that no-one ever forced them to eat anything they did not want to. I think it is pretty much the same with borrowing. I don’t think i have ever spoken to anyone with a debt problem who told me that they were forced to take the money they borrowed. In the UK, we are certainly living in a have now pay later culture. People are much more likely to buy on credit than save up for their purchases. We tend to buy now and worry about the consequenses later. To my mind there can be no doubt that this situation is fueling our increasing levels of debt.
Now people will say that my comment above is unfair. That the cause of their debt problem was not overspending. At the time they borrowed, their income was good and the repayments were no problem. They will say that their debts only became out of control after unexpected circumstances. For example the break up of a relationship, an extended period of unemployment or an unusually long maternity. This may be true. However, I would argue that if they had not borrowed so much in the first place, they would not have the same difficulties when the problems struck. We seem to have forgotten about the art of saving for a rainy day.
One sound piece of financial advice I heard was that everyone should have savings of at least 3 x their monthly take home income. This may sound impossible to most. However, just think how different things would be if we all stuck to this principle. We would be able to get through most problem times without borrowing.
But what about the banks? Many people say to me that surely the banks are to blaim. They should not have lent the money in the first place. The Government should put a stop to it. This is an interesting question. Surely no of us wants to live in a world where we are are not able to decide for ourselves whether we should borrow or not. We live in a culture where the underlying values are ones of personal freedom and choice. For someone to impose borrowing maximums on us would surely fly in the face of this.
Nevertheless, I am in favour of our banks taking more responsibility for who they lend to and how much they lend. I believe that banks need to spend more time with individuals looking at their ability to repay before agreeing to lend. Over the past 8 years I have come across many individuals who have been allowed to borrow from their banks when a simple income and expenditure excercise would have should that repayment was impossible. Clearly, if banks are to look more closely at they potential clients before lending, this is going to add cost to their sale process. However, perhaps this is a small price to pay if debt problems down the line are reduced.
The bank of England has today increased interest rates by a further quarter percent to 5.25%. This is a total of 0.75% since August 2006. OK, on the face of it, the increase does not seem much. ie if your mortgage is £150,000 then this is going to push up your payments by about £30. However for many people who are already struggling with debt, this may be the straw that breaks the camel’s back.
Serious personal debt problems do not normally come about overnight. They are normally the product of spending beyond one’s means over 2-3 years. Initially overspending is hidden because of the buffers offered by overdraft limits and credit cards. However, continued use of these things to maintain payments (or robbing Peter to pay Paul) ever so gradually increases a person’s over all debt. If this happens over a prolonged period, the debt will eventually grow so large that repayments can not be made.
If someone finds themselves in this position, an extra £30 per month is certainly going to make a difference. January tends to be the most difficult time of year for people struggling with debt problems as the Christmas overspending hits home. As such, for these people, an interest rate rise now could not have come at a worse time.
