Is bankruptcy a better option than a repayment agreement for those burdened with debt?
Hundreds of thousands of Britons struggling with the burden of massive credit card and loan debts are on plans that can drag out their repayments for more than a decade.
About 700,000 borrowers are on a debt management plan (DMP), according to R3, the trade body that represents insolvency practitioners. The plans are informal agreements, made between borrowers and lenders, that lower the repayments due each month by extending the length of the loans.
Peter Sargent, of R3, says: “These plans can prolong the distress experienced by a borrower when another procedure, such as bankruptcy, would have been more appropriate. Sadly it often means delaying the inevitable.”
The average household with unsecured debt owes £18,623 to credit card and loan providers, according to Credit Action, the debt charity.
The Ministry of Justice, the British Bankers Association and the Consumer Credit Counselling Service (CCCS) announced this week a new scheme aimed at borrowers temporarily struggling with debt. From April borrowers will be able to freeze their debts and make token payments of only £1 for six months.
Here Times Money looks at the benefits of an informal agreement and asks whether insolvency procedures, such as individual voluntary agreements (IVAs) or bankruptcy, could be better in some circumstances.
Borrowers with credit card or loan debt from at least two banks or building societies can enter into a DMP, either through a debt charity or a fee-charging company. They will set up and administer the restructured debt repayments with the agreement of creditors.
The main benefit of a DMP is that it is not a formal insolvency procedure so there is no risk that assets, such as a property, could be sold to clear the debt.
However, borrowers must often stick with the plan for years and companies are not always willing to freeze the interest charged on the loans — in some circumstances it can even be increased.
Research by R3 also indicated that more than a third of borrowers on a DMP had still been threatened with legal action by creditors chasing debt.
Deborah Shields, of the Money Advice Trust, which runs the national helpline, says: “There will be a proportion of borrowers on debt-management plans who should be considering bankruptcy or an IVA instead.”
Insolvency practitioners warn that fee-charging companies are guilty of pushing desperate borrowers on to a DMP. The companies, which promise “free advice” to “clear your debts”, pocket hefty arrangement fees of thousands of pounds. For example, Debt Unlockers levies an administration fee of 17.5 per cent plus the first repayment as a charge for setting up the plan. It says it always tries to reduce or freeze the interest charged by creditors.
CCCS will set up a plan and administer payments at no charge to the debtor, instead receiving funding from creditors. It will also carry out regular reviews to ensure that borrowers are on target to clear their debts over a set period.
To qualify for the token payments scheme, borrowers must have at least two unsecured debts and the creditors must adhere to the Lending Code. At least 5,000 people a month will be eligible for help under the token payment arrangement, according to estimates by CCCS. It is aimed primarily at borrowers who have suffered from a temporary cut in income, such as losing their jobs.
In the past, debt charities, such as National Debtline, have encouraged borrowers to suggest token payments to lenders if they are struggling financially for a short period of time. However, the new scheme will mean CCCS managing the token payments arrangements, acting as a middleman between the borrower and lender.The charity will carry out an assessment five months after a borrower began making token payments and could move a borrower on to an IVA or bankruptcy order if necessary.
Individual voluntary agreement (IVA)
An IVA is a formal alternative to a DMP, set up through the courts. It is a lighter alternative to bankruptcy, allowing borrowers to pay off as much of their debts as possible over a defined period, typically five years, and to write off the rest.
The repercussions of going into an IVA are less severe than bankruptcy, and in some circumstances borrowers can ensure that their property assets are not included in the IVA agreement. However, there are considerable drawbacks, the biggest of which is the cost. The fee for setting up and administering an IVA can be up to £4,000. Fee-charging firms have crowded the market for IVAs in recent years, arranging plans and adding a hefty fee on top.
A debtor is “discharged” from bankruptcy by the courts after only one year, free from all their debts. Over the course of the year a borrower’s assets, including their home, are distributed among creditors to help to clear the debt. Businesses will be closed down and courts can require salary payments to creditors for up to three years. However, a borrower’s pension pot is not included as an asset and cannot be touched.
The cost of presenting a bankruptcy petition to the court it £450, but insolvency practitioners charge an hourly rate on top of this of £200, recovered through the sale of the assets. Debt charities, such as Citizens Advice or CCCS, will only charge the statutory court fees.
There are longer-term repercussions if you go bankrupt.There are a number of professions that are not open to individuals who have been bankrupt and employers commonly ask applicants to declare a previous bankruptcy charge. A number of mortgage lenders refuse to provide loans to anyone who has been bankrupt.
Debt relief orders
Introduced in 2008, borrowers on a low income who are unable to repay debts of less than £15,000 can apply for a debt relief order (DRO), a cheaper alternative to bankruptcy that lasts 12 months. It is only available to people in England and Wales who do not own their own home and have assets of less than £300 and less than £50 a month of disposable income. If the borrower owns a car, it can be worth no more than £1,000. It costs £90 to set up a DRO.
For information regarding debt, contact CCCS (cccs.co.uk, 0800 138 1111); National Debtline (nationaldebtline.co.uk, 0808 808 4000); or Citizens Advice (citizensadvice.org.uk).
Case study: Eventually, I’ll owe nothing – that’s a great feeling
Mark Williams, 35, first applied for a credit card so that he could pay for the occasional purchase, but he quickly began using his plastic for everyday shopping.
Mr Williams, left, obtained more cards and ended up using four different credit card accounts to pay for everything from travel to clothes and groceries. He even began using one credit card to pay the minimum monthly payments due on the other cards. More than a decade after he applied for his first credit card, Mr Williams took stock of his debt. He owed £31,000 to MBNA, Barclaycard and Mint, the provider owned by Royal Bank of Scotland. He was also struggling to pay off a £9,000 loan.
He approached a fee-charging company after seeing an online advertisement. It promised to clear his debt by setting up monthly repayments to his creditors. However, Mr Williams would have to pay £200 to apply for the debt management plan and a percentage of his total debt. He walked away.
Eventually, Mr Williams called the Consumer Credit Counselling Service. The charity put him on a debt-management plan, without levying a charge, and persuaded his creditors to freeze the interest on his loans. “It was very stressful at the beginning of the process,” he says, “but now I know I will get down to owing nothing, and that’s a great feeling. I will never apply for a credit card again.”
Mr Williams now pays £135 a month towards his debt, down from £1,000 when he first started on the plan. Over the past four years he has paid off three of his four loans.