Getting back on your feet when facing the threat of bankruptcy
Mounting 'debt-lag' is leaving record numbers insolvent. Rob Griffin assesses the options available for those suffering financial distress
Saturday 08 May 2010
Record insolvency figures reveal that the economic crisis has left a lasting legacy. And even more people are expected to face the prospect of going bankrupt over the coming months.
Every year more than 100,000 people find themselves so overwhelmed by financial distress that they become insolvent – and experts are warning that the problem will not go away until people are given proper advice.
Mark Sands, head of bankruptcy at RSM Tenon, attributes the sky-high figures to a debt-lag effect where bills have piled up over a series of months due to overspending at Christmas and the ongoing impact of the financial crisis.
"Although the glass has started to look half full for the economy, it has very much been drained of every drop when it comes to individuals' personal finances," he explains. "Months of job losses and decreased earnings have taken their toll."
There are two main reasons why more people are having financial problems, according to financial adviser Geoff Penrice at Honister Partners: debts wracked up over a number of years and high levels of unemployment.
"Credit was so cheap and plentiful until the credit crunch that people were lured into taking more loans, maxing out their credit cards and taking out higher mortgages than they should," he says. "The banks' normal lending criteria also went out of the window as they bent over backwards to lend money to anyone they could."
Justin Modray, founder of financial website CandidMoney.com, believes the "buy now, pay later" culture must also take its share of the blame. "The trouble is most of those buying now and paying later have little idea of just how crippling debt can be, nor the sizeable sums of interest they will end up paying," he says. "When you start getting into debt it is not hard to fall into a vicious downward spiral."
So what are the options for those in real financial difficulty?
Well, for those people who find themselves completely unable to meet their repayments, there are three main options for them to consider: striking a deal; entering an Individual Voluntary Arrangement; or declaring themselves bankrupt. Which is most suitable will depend on an individual's circumstances and debt levels.
1. Reach a compromise with creditors
The first – and easily the most preferable – is to reach a compromise with creditors and this usually involves explaining the situation to them in a letter and including a timetable of when they will be paid.
The obvious benefit is that the problem will be resolved amicably, but the disadvantage is that they're not legally binding so creditors can easily disregard them at a later date and demand the debt is paid in full.
If one or more of your creditors has obtained a country court judgment against you then the court itself may decide to make an administration order. This is an official procedure whereby you make regular payments to the court which goes towards the total sum owed to your creditors.
However, there are restrictions. Your total debts must not be more than £5,000 and you will need to have enough regular income to make weekly or monthly repayments. Although you do not have to pay a fee for this order, the court will take a small percentage towards its costs from the money paid.
If your circumstances alter you can apply to change the order – but it's important to acknowledge that simply failing to pay regularly could lead to it being cancelled altogether and your creditors given the green light to take action against you.
2. Individual Voluntary Arrangements
This is best defined as a formal proposal to a person's creditors to pay all – or part – of their outstanding debts. Generally it will suit those people who cannot make their monthly repayments in full but have some free cash each month that can be given to their creditors. It is legally binding on you and your creditors, and if the terms are broken you could be made bankrupt.
The first step is finding an insolvency practitioner who will act as a supervisor of the arrangement and, for a fee, will help you get to grips with your finances and put together a plan for paying back your creditors.
This practitioner will then explain the proposal to the court after which a meeting of creditors is often called for the details to be considered. If the proposal is agreed at this meeting – and it needs the backing of creditors holding 75 per cent of the debt's total value – it will be allowed to proceed.
The length of time an IVA lasts will depend on the proposal worked up with your insolvency practitioner. However, most are based on monthly contributions from your disposable income and generally last five years.
The final route to go down, of course, is bankruptcy. Although creditors can petition for someone to be made bankrupt, in about 80 per cent of cases it will be the decision of the individual concerned.
Opting for bankruptcy enables people to walk away from their overwhelming debts and make a fresh start, subject to restrictions, while their assets are shared out fairly among their creditors.
The process involves petitioning the court and paying a fee of around £500, before explaining the circumstances to a judge. Due to the high number of bankruptcies taking place across the country, there might be a waiting list of several weeks.
An official receiver is then appointed who will be responsible for deciding which assets can be kept and what needs to be sold off to repay the debt. Strict restrictions will be in force governing issues such as the level of credit a bankrupt can obtain.
Although the Enterprise Act, which came into force in April 2004, has reduced the length of time for bankrupts to be discharged from such restrictions to a year – or even less in some cases – it is still the most restrictive option of the three.
You will have to give up any possessions of value, as well as the interest in your home. It will almost certainly involve the closure of any businesses you run and the dismissal of your employees.
Once a bankruptcy order has been made you will need to comply with the official receiver's request for information about your financial affairs; provide them with a full list of your assets and what you owe; stop using your bank, credit cards, and other accounts immediately. You may also have to explain in court why you are bankrupt. If you do not co-operate you could be arrested.
There are also a number of criminal offences for an undischarged bankrupt. These include obtaining credit of £500 or more without disclosing your bankruptcy. Also, even after the bankrupt has been discharged, it's not unusual for their credit rating to be affected for a further six years.
Of course there are ways for people to prevent repeating their mistakes and getting into future problems, according to Justin Modray at CandidMoney.com, who points out that the best way to avoid problems is not to spend more than you earn.
"If you need to borrow over shorter periods then try to take advantage of zero or low interest rate credit cards – but have a plan to repay the balance before interest starts to pile up," he says. "For longer term borrowing, consider a low cost loan or, if you have plenty of equity in your home, a mortgage."
Avoiding store cards – which often charge punitive rates of interest – and keeping on track of your finances with a strict budget are also essential. "A monthly budget is an excellent way to instil some financial discipline so keep a record of all your expenditure and then see where you can cut unnecessary costs and get better deals."
There are other financial products that are worth considering that may help you during the tough times, adds Penrice at Honister Partners. "To guard against the risk of unemployment, people should ideally have around three months' salary as a reserve to tide them over should the worst happen," he explains. "It would also be worth considering ASU insurance, which can give protection against loss of income due to accident, sickness and unemployment."
Even so, the financial problems being experienced by many are not expected to ease any time soon. In fact, Sands at RSM Tenon warns we are likely to continue seeing record numbers of people looking towards insolvency during 2011.
"The UK's debt culture built up over the last decade has intensified the effects of the financial crisis and people need to understand the consequences of taking on debt and be given incentives to rebuild their savings," he says. "We are seeing record levels for the third quarter in a row so advice is crucial to help the hundreds of thousands of people suffering financial distress who are on the verge of bankruptcy."
Deep in debt: the average household owes £57,950
Another month goes by and we're all deeper in debt. According to money charity Debt Action, our collective personal debt comes to £1,460bn – which means as individuals we owe more than what the whole country produces in a year.
And the debt problem is getting worse. The latest available figures – for March 2010 – show that we fell a further £0.6bn deeper in debt. The interest payments on that debt were £67.8bn in the last year alone.
It means the average household now owes £57,950 while the average amount owed by every UK adult is £30,258.
The average interest paid by each household on their total debt is approximately £2,692 each year while £186m-worth of personal interest is paid out each day in the UK.
Apart from mortgages, we also owe an increasing amount on plastic and loans. Debt Action says the average consumer borrowing through credit cards, motor and retail finance deals, overdrafts and unsecured personal loans soared to £4,593 per average UK adult at the end of March 2010.
There are 9,500 new debt problems dealt with by Citizens Advice each day. Meanwhile a property is repossessed every 11.4 minutes and someone will be declared insolvent or bankrupt every 3.69 minutes.
*Citizens Advice Bureau: www.citizensadvice.org.uk
* The Insolvency Service: www.insolvency.gov.uk
* Consumer Credit Counselling Service: www.cccs.co.uk
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