There are no easy ways to wipe your debts clean.
Firstly, you need to acknowledge there’s a problem. For whatever reason, you got into debt. You might have fallen ill, made a bad financial decision or just let repayments get on top of you over a number of years.
It doesn’t matter. There’s nothing you can do to change what happened in the past and you need to address your situation here and now.
Here’s the bad news: If you can afford the repayments and, especially if the creditor (the company who you owe money to) is secured (over your home or car for example), then that’s your problem.
Here’s the good news: If you can’t afford the repayments and, especially if the creditor is unsecured (as is usually the case with loans and credit cards), then there’s a chance that you could wipe your debts clean. That’s the creditor’s problem.
Here’s a typical example of someone with this kind of problem debt:
Michael has found himself £30,000 in debt from unsecured loans and credit cards. His capital and interest repayments on this debt total £600 per month.
However, after paying his essential monthly outgoings, such as mortgage, utilities and food, Michael only has £300 each month left over.
Using Michael as an example, this article will explain how you turn a situation like this into the creditors’ problem, as well as giving you the main options available – a Debt Management Plan (DMP), an Individual Voluntary Arrangement (IVA) and Bankruptcy. On a side note, if Michael had debts of less than £20,000 and couldn’t afford to repay more than £50 per month, he may have been eligible for a Debt Relief Order.
Debt Management Plan (DMP)
A DMP is an informal arrangement whereby you, or a company acting on your behalf, write to each of your creditors requesting to your lower monthly debt repayments.
Creditors will often agree to this if they can see that you are unable to afford your present repayments. You can show your creditors how much you are able to afford using a financial statement
If you choose to go through a company to set up your DMP, this company will ask that you make a single monthly repayment to them, which they then distribute amongst your creditors.
A DMP can give you the breathing space of lower monthly debt repayments, perhaps allowing you to catch up on essential household bills.
Michael contacts a (fictional) company, Debt Panda. They recommend a DMP to him.
The DMP Company writes to each of his Michael’s creditors on his behalf and all of them agree to lower his monthly repayments. Overall, Debt Panda negotiates Michael’s repayments down to £300 per month, from the previous £600 per month, and Michael begins paying Debt Panda this amount.
Michael is relieved to have everything sorted.
- The interest on Michael’s debt was 10% per annum. 10% of £30,000 is £3,000 per year in interest, or £250 per month.
- Also, Debt Panda take 15% from each of his monthly repayments as their management charges (a lot of unscrupulous DMP companies charge much more). 15% of £300 per month is £45.
- This means that, of the £300 per month Michael is paying, £250 goes towards interest repayments, £45 to the DMP Company management fees and just £5 goes towards capital repayments.
After paying Debt Panda £18,000 over a 5 year period, Michael contacts them to ask what he owes each of his creditors now.
Here’s a breakdown of what he repaid each year and where the payments went:
|Year 1 (£)||Year 2 (£)||Year 3 (£)||Year 4 (£)||Year 5 (£)|
|Debt owed at beginning of the year||30,000||29,940||29,874||29,801||29,721|
|Michael’s payments to the DMP Company||3,600||3,600||3,600||3,600||3,600|
|Interest charged (10%)||(3,000)||(2,994)||(2,987)||(2,980)||(2,972)|
|DMP company fees (15% of Michael payments)||(540)||(540)||(540)||(540)||(540)|
|Debt owed at the end of the year||29,940||29,874||29,801||29,721||29,634|
So, by the end of 5 years, and after paying the DMP Company £18,000, Michael has managed to pay off just £366 of his debt.
Michael is not happy about this.
If this pattern continued, it would take Michael over 41 years to repay his £30,000 debt, by which time he would have made repayments totalling over £147,600.
It could have been much worse for Michael – many people enter into these types of arrangements, only for their debt to grow even further. Michael could still get threatening letters and debt collectors could still come knocking at his door and, as a DMP is an informal arrangement, creditors can change their mind about the DMP at any time and demand that repayments return to their previous level.
Nevertheless, if you are considering a DMP but don’t feel able to arrange one yourself, you should contact StepChange. They’re a debt charity, can provide you with free, impartial debt advice and arrange a DMP for you with no fees.
Individual Voluntary Arrangement (IVA)
You might have seen the adverts or received a cold call:
“New Government Legislation Allows You To Write Off Up To 80% Of Your Debts”.
The “New” Government Legislation referred to is actually the Insolvency Act 1986 (not really new) and the product they are trying to sell you is an IVA.
An IVA is a formal arrangement with your creditors to make monthly repayments over a set period, typically 5 years, as full consideration for your debts owed.
To enter into an IVA, you need a licenced Insolvency Practitioner (IP) to act on your behalf and write a Proposal to your creditors. If 75% or more of your creditors accept this Proposal then all of your creditors will be bound by the IVA. Your creditors should no longer contact you and most crucially, if you complete your IVA, all of your debts are wiped clean.
In Michael’s situation, it may work as follows:
Debt Panda refers Michael to another (fictional) company Timpson Brown who can propose and administer IVAs.
The IP at Timpson Brown writes a Proposal to Michael’s creditors. His IP asks his creditors to accept £300 per month over a period of 5 years in full and final settlement of all of his debts.
His creditors accept the Proposal.
In an IVA, the interest on the debt is frozen on the day the IVA is accepted.
The IP charges set-up fees of £2,000 (of which £1,000 was paid to Debt Panda as a referral fee) and 15% of everything Michael pays into the IVA after that. Everything else is distributed to creditors.
Here’s a breakdown of how the maths might work:
|Year 1 (£)||Year 2 (£)||Year 3 (£)||Year 4 (£)||Year 5 (£)||Total|
|Michael’s contributions into the IVA||3,600||3,600||3,600||3,600||3,600||18,000|
|Payments to creditors||360||3,060||3,060||3,060||3,060||13,600|
|% of debt repaid||4.5||10.2||10.2||10.2||10.2||45.3|
In the instance, Michael paid a total of £18,000 into his IVA and his creditors received 45.3p for every £ which Michael owed. Michael would walk away at the end of the IVA, debt free.
Michael is happy.
There are risks to using an IVA, though.
- If Michael had lost his job and couldn’t keep up with payments, there’s a chance that his IVA could fail, in which case, Michael would be back to square one.
- If Michael had a big pay increase and could afford to pay more into his IVA, then he would be asked to pay in 50% of any additional surplus income.
- If Michael owned a property, he would be expected to release equity (up to 85% LTV) from it in the final year of his IVA. If he wasn’t able to, the IVA would be extended for a further 12 months.
There are a lot of rules associated with IVAs that you can find here (47 pages for a straightforward consumer IVA).
Nonetheless, when seeking to wipe your debts clean, it is a much better solution than the DMP illustrated in Michael’s example.
A lot of people are surprised to hear that creditors are prepared to accept just a percentage of what is actually owed to them. There are a few reasons why creditors are prepared to accept this:
- By this stage it isn’t really your creditors who are handling your debts – they’re not the same people who leant you the money or even the people that are chasing you for the debt. Your debt has probably been passed on again – this time to major voting bodies such accountancy firm Grant Thornton (who happen to be one of the biggest providers of IVAs themselves) – who vote on behalf of the creditors. There’s a certain amount of vested interest.
- It costs creditors money to keep chasing your debts. It can be more cost effective for them to accept an IVA rather than relentlessly chasing you, especially if they know that the IP is someone who will manage the IVA effectively and deliver a return to them.
- This is perhaps the most important consideration – creditors usually get much more in an IVA than what they would otherwise receive in bankruptcy.
Bankruptcy is usually the quickest and cheapest method to wipe your debts clean, but it comes with many catches – your assets will be put at risk of being repossessed, you could lose your job and your bank account may be closed.
However, these might not be as bad as they sound – you only need to declare assets with a value of more than £500, your job will only be at risk if you work in certain industries or are a Company Director and there are numerous basic bank accounts you can reapply for. Here’s a breakdown of what it might cost Michael:
Michael applies for bankruptcy here and pays the £680 application fee
A bankruptcy order is made. Michael has an interview with an Official Receiver who assesses him to make monthly payments of £200 per month for a period of 3 years under an income payments agreement (IPA).
He has no assets.
Provided he cooperates with the Official Receiver, Michael will have his debts wiped off.
Michael’s income payments in bankruptcy are lower than what his IVA payments were due to more “allowable expenditures”. See this income and expenditure chart to get a rough idea of your monthly payments would be in bankruptcy
Over three years, Michael would therefore pay £7,200. So, added to the bankruptcy application fee, the bankruptcy costs him £7,880 to wipe his £30,000 debts clean. After various fees taken by the Official Receiver and the government Michael’s creditors would not receive more than £3,000, or 10p for every £ which Michael owed them.
Cost for Michael to clear his £30,000 debt:
From a purely financial point of view, bankruptcy would be the cheapest option for Michael. However, bankruptcy should not be taken lightly as it could have serious implications, which vary in severity depending on your individual circumstances.
I have previously worked as an Insolvency Administrator for a company which administered IVAs and can understand the pros and cons behind each option. The worst option, usually however, is to bury your head in the sand and hope the problem will go away by itself – it won’t.
12,225 people entered into an IVA between April and June 2016, as opposed to 3,537 people who entered into bankruptcy during the same period.
Importantly, if you have any mis-sold PPI not yet reclaimed (where have you been for the last 10 years?) you should do so immediately. It could significantly reduce the amount of debt you owe.
My name is Edward and if you would like to contact me regarding debt matters, you can do so by emailing me at email@example.com.