Avoid bankruptcy through debt counselling, IVAs

Are you about to check into the monetary morgue; are your financial assets in freefall? You might be viewing bankruptcy as an easy-way-out option, but there are other avenues to fiscal redemption and continued cordial relationships with creditors.

It was heartwarming to learn from a recent Merrill Lynch / CapGemini survey, that 448,070 Britons have non-free falling financial assets, excluding property, worth more than $1 million (£543,000). This number represents a 7.5% increase on last year and a growth rate more rapid than in the USA (6.5%) and the rest of Europe (4.5%).

The reverse of the coin, however, is provided by figures from the Department of Trade & Industry (DTI) which show that personal bankruptcies leapt to 23,251 in the first three months of this year. This is a 73% increase compared to the same period in 2005, and a 13% rise on the previous quarter.

The bankruptcy peak of the early 1990s has been eclipsed and financial experts are predicting a final tally of 100,000 insolvencies by the end of this year. If that estimate holds true then it will mean 259 people a day going bust. Will you be one of them (already a lost financial cause) or, if teetering on the chasm of pecuniary oblivion, what steps can you take to retrieve the financial higher ground?

Collectively British consumers are in debt to the tune of over £1 trillion. Barclaycard has reported that customers are defaulting on £1 in every £5 they borrow; Lloyds TSB has announced that bankruptcies account for 50% of bad debt charges in its retail banking division (note, though, that Which? estimates banks make £4.6 billion a year from fees and interest charges levied on unauthorised overdrafts).

Declaring bankruptcy might seem to be a simple way out of the debt swamp, but the ramifications need to be carefully assessed. Yes, the Enterprise Act of 2004 allows the discharging of a bankrupt's debts after one year instead of the previous three-year term, but your credit file will stay marked for another five years. This fact will present difficulties when you try to take out a bank account, mortgage or even a mobile phone contract. And speaking of mortgages, bankruptcy invariably entails seizure of house, car and other valuable possessions. Orders for house repossession rose to almost 23,000 in the first quarter of 2006, a 57% increase on the same period last year.

If you have no property, no or little income and you're not a member of the aforementioned $1 million assets club, then maybe bankruptcy could be the best option in the face of financial meltdown but it is very much a last resort. Note that in certain professions, for instance solicitors and accountants, you can lose your livelihood by going bankrupt.

Alternatives to declaring bankruptcy

An individual voluntary arrangement (IVA) might be the preferred alternative. DTI statistics for the year's first quarter show that 7,961 people took this route, a substantial 141% increase on 2005's first quarter. IVAs are attractive to middle-class debtors who shy away from the humiliation of bankruptcy and to graduates endeavouring to offload outstanding student loans (the Government has closed a loophole in the bankruptcy laws that allowed student loans to be written off). Provided that repayments are kept-up, you are unlikely to lose your home or professional job under an IVA order. It typically costs around £5,000 to set up (debt management companies have been targeting what is seen as a lucrative market with some aggressive promotion of late) and usually lasts for five years. Your credit file is marked for a total of six years as it is with bankruptcy.

Repayments, based on your income and expenditure, go into a trust account which the insolvency practitioner uses to extract its fees and to pay creditors. An IVA requires 75% of creditors to sign up before it can be implemented. According to accountants KPMG, the average debt of those using the IVA route is £60,000, and the average that creditors may expect to receive is around 40% of that. There are government proposals in hand for a streamlined IVA, which borrowers who owe less than £30,000 would be able to sign up to, even if it is against the wishes of their creditors.

Whether you are considering bankruptcy or an IVA as a solution to your debt problem, you should speak to a debt adviser first. Get advice from the right source and take preventive rather than corrective action. Debt counsellors are reporting record numbers of people seeking help and, worryingly, research shows that 60% of those in severe financial difficulty are under the age of 35. In fact, more than a third of those aged between 25 and 34 admit to not thinking they are spending money when using debit or credit cards.

As the Consumer Credit Counselling Service says, "Budgeting does seem to be a lost art in the age of the credit card."

If you're close to the financial edge, keeping a budget is essential. Then look at loan commitments in order of priority. Mortgage and other debts secured on a property should head the list. With unsecured debt look to pay down the more expensive loans first. Test your financial stability by envisaging the repercussions of, say, a two percentage point rise in interest rates (an extra £119 per month on a £100,000 repayment mortgage at 4.5%). If you lost your job do you have sufficient cash to tide you over for three to six months? Is there term insurance in place should your partner (and their income) die? How close would a divorce bring you to bankruptcy?

Minimise your potential for insolvency by getting a full financial health check. Debt counselling is available from several sources:

• Citizens' Advice Bureaux (see phone book for local branch)
• Consumer Credit Counselling Service 0800 138 1111
• Community Legal Service (England and Wales) 0845 123 2321
• National Debtline 0808 808 4000

Avoid debt consolidation companies who make extravagant claims and high charges and be wary of advice from your bank especially if it involves selling you a product solution.

26 June 2006 © Moneyextra.com

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