Debtors are warned that bankruptcy is no soft option

Changes to the law may make this seem an easy way out, but there are many pitfalls. David Prosser reports
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The Independent Online

Thousands of cash-strapped borrowers who are preparing for bankruptcy have not understood the hardship they will face as a result, according to a warning from the debt specialist One Advice. It claims more than 110,000 people are considering declaring themselves bankrupt this year, in many cases because - wrongly - they consider it to be a soft option.

"A growing number of people with huge debts, and recent changes to legislation making it easier for people to climb out of bankruptcy have resulted in a huge increase in personal insolvency applications," says One Advice's chief executive, Chris Holmes. "However, many successful applicants will be unaware of the difficulties they face as a result of doing this."

Almost 15,400 people were declared bankrupt in the first quarter of the year , a 12 per cent rise on the last three months of 2005, and a 51 per cent increase on the same quarter of last year. The increases reflect a five-year trend - the number of personal bankruptcies has risen every year since 2001, but began to spike particularly sharply upwards in 2004.

Tony Supperstone, a consultant at accountants BDO Stoy Hayward and president of R3, the insolvency practitioners' trade body, says the Enterprise Act passed that year has lessened the stigma attached to bankruptcy. "It now looks very attractive - you can be discharged from bankruptcy after six to 12 months, with all your debts cleared."

Frances Walker, of the Consumer Credit Counselling Service (CCCS), says someone going bankrupt can now expect to be discharged after an average of eight months, compared with at least three years before the law changed. "Many borrowers see bankruptcy as a new lease of life," she says. "For many, being free from the worry of the debt is such a relief that it is worth the consequences of the bankruptcy." The problem, debt experts warn, is that borrowers may not realise how serious those consequences are.

To start with, bankrupts lose all control of their assets, including possibly even their share of the family home. The official receiver, or an insolvency practitioner, divides up the assets and shares them out among the bankrupt's creditors.

"Bankrupts are not allowed to obtain credit of more than £250 and have to seek permission to use bank accounts and credit cards - only basic living expenses can be paid, with any surplus going to pay off creditors," adds Holmes. "Any income earned during the bankruptcy order can be claimed against for an income repayment order for up to three years." That's assuming the bankrupt is able to earn an income. In professions such as the law, bankruptcy could mean losing your licence.

All insolvencies stay on your credit file for at least six years. As a result, bankrupts are likely to find it particularly tough to get credit for an extended period after being discharged - the best case is they will have to pay substantially higher rates of interest. For these reasons, the CCCS says bankruptcy only makes sense for a small number of people with debt problems - of the cases it handled in the first quarter of the year, it recommended bankruptcy to just 12 per cent of borrowers. "If you're a young person without much in the way of assets, it can make sense," says Walker. "But bankruptcy does still have very serious implications."

A better bet, for many borrowers, may be to come to an agreement with creditors - either an informal pact to make fixed repayments over a set period, or an individual voluntary arrangement (IVA), a legally-binding deal that is less serious than full-blown bankruptcy.

The downside to IVAs is that it is likely to take much longer to be clear of your debt - five-year plans are common. But borrowers retain much more control of their assets, and their professional status is less likely to be affected. And the impact on your credit rating will also be less disastrous.

Ways to deal with a debt crisis

* Debt management plans: This is the least formal way to get on top of your borrowing. The idea is to persuade your creditors to agree that you will repay what you owe over a realistic time period - say five years - with affordable fixed payments each month.

* You can try to negotiate with creditors yourself, by writing to them to propose a repayment schedule. Alternatively, groups such as Citizens Advice and the Consumer Credit Counselling Service will negotiate on your behalf, usually for free. Bear in mind that you can't force lenders to agree to this sort of scheme. And the agreement is not legally binding - you could be asked to pay in full later.

* Individual voluntary arrangement (IVA): An IVA is a more formal version of the first option, and requires an authorised insolvency practitioner to arrange and oversee the deal. All your lenders can be forced to accept the terms of the IVA if 75 per cent of creditors by value of the total debt agree.

* Insolvency practitioners charge a fee for their services, which will add to your debt. But they may be able to negotiate a freeze in interest charges.

* Bankruptcy: This is the most extreme option. Your assets - including property - are divided up between your creditors, with the insolvency courts ruling on who gets what. You may be discharged after a year, leaving you debt free, but the bankruptcy remains on your credit file for six years, with serious implications for your finances.

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