Problem Debt Guide

Introduction

This section of our Debt Guide deals with problem debts. We start off by looking at the important differences between secured and unsecured debts, then go on to discuss ways that you can manage your debts. This section will explain some of the terms that you may have come across such as IVAs, CCJs, Insolvency and Bankruptcy.

Please note that the law in this area differs between England & Wales and Scotland. This section of the guide explains how debt is handled in England & Wales. We hope to add more details that are relevant to Scottish Law in the near future. In the meantime you may find it useful to visit the debt pages of the Citizens' Advice Scotland website or the Scotland pages on the National Debtline website.

Types of Debt - Secured and Unsecured

Let's start by looking at the basics. Fundamentally, there are two types of debt, secured and unsecured. A secured debt is a debt that, as the name implies, is secured on an asset that is owned by you. Secured loans are usually for large amounts of money, typically over £15,000 and because the lender has security for the loan, secured loans generally attract a lower interest rate. A lender can take any asset as security for the monies lent but usually monies would be secured by a legal charge which is placed on a property, normally your home. So what does this mean? Quite simply, this means that in the event that you default on the payment of the loan as agreed with the lender (also known as a creditor), then the lender can apply to the courts for an order for possession and sale of the secured asset, to satisfy their debt. The costs of this action can add many thousands of pounds to the original amount borrowed.

Unsecured debts are loans which are typically less than £15,000 for which the lender does not require any security but which consequently attract a higher interest rate. If you were to default on an unsecured loan, the lender could not make an immediate application to sell any of your assets. The first thing that an unsecured creditor would have to do to recover their money, would be to obtain a Judgment against you from the County Court. If you did not respond to the Court summons, the creditor could then take enforcement action. There are several ways in which a creditor can enforce their Judgment and one way would be to apply for a legal charge on your property, which effectively, would turn an unsecured debt into a secured one.

Credit cards and small loans are usually unsecured debts and on most occasions, these are the debts that cause the most problems. The is because there is no security for the debt. So creditors are far more energetic in their pursuit of these debts and have less patience, due to the fact that they are at a high risk of not recovering the debt. As we progress, we will cover how to deal with temporary and long term debt management and how to deal with creditors or their agents and debt collectors. We will cover what tactics they use, how to make out a list of income and expenditure (statement of affairs) and how to present an informal proposal to your creditors. We will cover what your creditors can and can't do to you and what you can do to protect yourself from harassment and how you can respond to legal action taken by your creditors. Finally, we will cover formal remedies such as the Individual Voluntary Arrangement and Bankruptcy.

Your Debts and Your Home

The biggest secured debt that most people have is their mortgage, so it is sensible to consider whether your home and mortgage are part of the problem. But there is something about houses in Britain that often stops sensible people from thinking logically. Perhaps it is all those property programs on the TV, or the daft cliche that renting is 'throwing money away'. But if you have a serious debt situation and a house, then you need to step back and consider whether your house is part of the problem: are you paying more in mortgage and secured loans than you can really afford on your income? Or perhaps your house could be part of the solution if selling it could clear a lot of your expensive debts. Often people find they can rent somewhere nicer for less money than they are spending on a mortgage.

Ostrich Syndrome - Facing up to your Debts

As we have already discussed, by far the worst thing that anyone can do when they find themselves in financial difficulty, is to bury their heads in the sand in the hope that the problem will go away. Problems do not go away by ignoring them, they only escalate. The best thing that you can do when there is a problem with making a payment on a loan or credit card, is to take positive action by informing your creditors of your position. How you handle the situation is entirely dependant on the circumstances, but if yours is a short term problem, this should be relatively simple to resolve by making a sensible proposal to your creditor(s). The quicker that you do this, the better. Your creditors will be far more appreciative of you informing them about a problem as soon as it happens rather than waiting and the first thing they get to know about it is by you missing a payment. It is vitally important that you advise them of a problem before this happens.

Approaching Creditors

Your first approach should be by telephone but you should always follow this up in writing. You should always make a diary note of when you called, what time you called and who you spoke to. When you set out to deal with your debt, there are 3 important rules:

• Rule No.1: Put everything in writing
• Rule No.2: Get their acceptance in writing
• Rule No.3: Always keep copies of your letters and notes of dates and times you call and the names of people that you talk to

When you call your creditor, have your account number ready and start by telling them the problem. If, for example, you are suffering a minor illness or injury and are likely to be off work for a short period of a few weeks up to say 3 months, you should ask them for a payment holiday or request a lower payment for that period of time. Most lenders will not have a major problem with this if you have acted quickly, the likelihood is that they will be happy to help. Once you have reached an agreement with the creditor, you should confirm this in writing and keep a copy for your records.

If on the other hand, you have lost your job but expect to regain employment in the not too distant future or you are suffering an illness that will keep you away from work for a considerable period, you will need to tackle the problem slightly differently. In these circumstances, you will need to draw up a list of your income and expenditure: a Statement of Affairs (SOA) to illustrate your position to your creditors. If you do this and then make an offer in accordance with your ability to pay, you will be demonstrating a responsible attitude to your creditors and they will be more inclined to help you.

Making up your SOA is quite easy. Using our SOA Calculator, you can easily make a list of your income and any benefits that you receive. From this, you deduct all your essential outgoings such as mortgage, rent, council tax, gas, electricity, water rates, tv licence, insurances, food, clothing, petrol, car maintenance, other travel expenses, child minder, medical necessities, haircuts, emergency fund (allow £30-£50 per month for this) and any other legitimate expense (fags, booze and holidays etc are not considered essential outgoings). Once you have deducted your outgoings from your income, this will leave you with your expendable income. From this, you can calculate what you can pay to your creditors on a pro rata basis. For example, let's say that after doing your calculations, you have £350 per month spare to throw at your debts. Let us also say that you have 5 creditors with balances of:

• Creditor 1: £1700
• Creditor 2: £3780
• Creditor 3: £1455
• Creditor 4: £2750
• Creditor 5: £2250
• Total £11935

We now divide your expendable income (£350) by the total amount of your debt (£11935) and this will give you your multiple. e.g. 350/11935 = 0.0293255. We now apply this multiple to the debt outstanding to each creditor, i.e.

• Creditor 1: £1700 X 0.0293255 = £49.85
• Creditor 2: £3780 X 0.0293255 = £110.85
• Creditor 3: £1455 X 0.0293255 = £42.67
• Creditor 4: £2750 X 0.0293255 = £80.65
• Creditor 5: £2250 X 0.0293255 = £65.98
• Total £350.00

(Note: this is only an example and the equation will work out the same whatever multiple you come up with. Don't worry if your figures are much less than in the example shown, you can only make an offer in line with your ability to pay).

Now that you have established what you can afford to pay, you now need to make a proposal of payment to your creditors, giving them an illustration of your position. The following approach is suggested:

Hopefully, this will give you a solution to your immediate problems but this is only a short term fix, if your position is more serious than this, you may need a formal solution to your problem and we will cover this shortly.

County Court Judgements

Sometimes, no matter how reasonable your offer is, a creditor will decide that they want to take Court action and they will issue a summons for the money that you owe them, in the County Court. You should never, ever, ever ignore a County Court summons. If you receive one, you should not panic. You have to remember that the Court is totally impartial, they are not against you. It is the function of the Court to ensure fair play and a Court will never allow your income to be lowered below a level that you need to live on, provided that you respond to the summons.

If you ignore the summons then the creditor will certainly obtain their Judgment against you by default. If the creditor obtains a default Judgment and asks for payment 'forthwith' this means that you will not be given time to pay and this can lead to all sorts of problems and it makes it easy for the creditor to get a charge over your property if you own your home. Effectively, this turns an unsecured debt into a secured debt.

If you receive a summons, you will also receive a response pack and instructions on how to fill in the forms. Take your time and complete the income and expenditure sheet and state how much you can afford to pay on a monthly basis. When you have completed the forms, send them back to the Court and also send a copy to the creditor and remember to keep a copy for yourself.

The Court will ask the creditor if they accept your offer. If they do, then the Court will make an order that you pay the amount that you have offered. One good thing about a Judgment is that if the debt is under £5,000 then the creditor will not be able to claim further interest as interest ceases on Judgment. Provided that your circumstances remain the same,the creditor cannot take any further enforcement action against you if you maintain this payment, but if you default, (stop paying) then there are several methods of enforcement that the creditor can apply to the Court for.

If the creditor does not accept your offer, then the Court will set down a hearing date. It is vitally important that you attend the Court on the date and time that they inform you. If you do not, then you run the risk of the creditor persuading the Judge that they should be paid more than you have offered. There is nothing to be frightened about by attending Court. You should take with you all previous correspondence with the creditor, including the SOA that you sent to them and your offer of payment. If it is clear from your income and expenditure that you are paying what you can afford and the creditor has rejected this, the Judge can consider this a waste of the Court's time. They have the discretion to reduce payments and they can deny the creditor's costs.

Insolvency

The technical definition of insolvency is that if you are unable to pay your bills as and when they fall due, then you are insolvent. If you are insolvent then there are only 3 remedies that you can consider. A Debt Management Plan (DMP) an Individual Voluntary Arrangement (IVA) or Bankruptcy.

Individual Voluntary Arrangement

There has been a sharp increase in IVAs over the past few years and they have evolved significantly over this time. An IVA is a formal arrangement with your creditors which is sanctioned by the Court. Unlike a DMP an IVA is legally binding on the creditors so they can't change their minds like they can with a DMP. An IVA is a proposal to your creditors, that you will pay a set amount, usually quite a bit less than you actually owe, over a set period of time. You cannot propose an IVA by yourself, you need to approach an Insolvency Practitioner (IP) to do this for you.

A word of caution here. All IPs are not the same so shop around. Some of the bigger firms will charge a lot more in fees and you should not in any circumstances use fee charging agencies that you see advertising in the local press. These people will charge a high fee to take some details from you and then introduce you to an IP and you can do this yourself for free. Do not use any IP or an agent who asks you to pay fees upfront. These days, IPs agree their fees with your creditors and their fees are paid out of the monthly contributions that you make to your IVA.

For an IVA to be accepted, you need to obtain 75% of the creditors to vote for your proposal. It doesn't matter if the others don't accept it as they will be legally bound by it if you obtain the required 75% whether they like it or not. Your IP will initially be known as your 'Nominee'. He will draw up a statement of affairs and will contact all of your creditors. Your creditors will be sent a proposal and will be asked to vote at a Creditors Meeting (CM). Most CMs these days are convened electronically and the vote takes place via fax, so it is unlikely that you will physically have to attend. However, you must keep yourself available to be contacted on the day of the meeting, just in case there are any modifications.

At the CM the vote will be taken and one of 4 things can happen. The IVA is accepted, it is accepted with a modification, or it will be rejected or adjourned. If it is accepted, then your nominee now becomes your 'Supervisor' and will then commence the administration of your IVA.

If the creditors are not entirely satisfied with your proposal, they can ask the nominee to modify it. If you agree to the modification, the IVA will succeed and your nominee now becomes your Supervisor.

If the proposal is rejected, this does not mean that this is the end of the matter. The nominee can ask for the meeting to be adjourned and get together with you to discuss the matter further. Then he can put a new proposal to the creditors at a new creditors meeting.

The criteria for an IVA has increased recently from 25% to 40%. This means that the minimum that creditors will accept in repayment is 40% of your debt. Added to this is the cost of your IPs fees, which on average would be about £9,000. This fee is spread over the period of the IVA and is paid through the monthly contributions that you make, you do not have to find this separately. An IVA usually lasts between 2 and 5 years, but this can be extended if necessary.

If you own your own property, a common clause that is inserted into IVA agreements these days is the remortgage clause. What happens here is you pay your IVA payments for 4 years and then at the end of that time, if you can afford to, you can remortgage and introduce a lump sum into the IVA and the IVA would then end early. If you cannot afford to remortgage, (the creditors can't force you to if you can't) then the IVA would continue into the 5th and final year and any outstanding debt at this time, is legally written off.

To give an example of what you can expect to pay, let's say that you owe £60,000 in unsecured credit cards and loans. Take 40% of this figure and add £9k to that then divide this figure by 60, i.e. 60,000 x 40% = 24,000 + 9,000 = 33,000/60 = £550. This is the minimum amount that the creditors would accept in an IVA, but if you can afford more, then they will want you to pay more.

An IVA should be considered if you have significant assets to protect, such as your home. The advantages of an IVA are that a successfully completed IVA has less of an impact on your credit rating, there is no advertisement in your local press and you are not restricted as much as you would be in bankruptcy.

Bankruptcy

Bankruptcy is and always should be a last resort. Bankruptcies, like IVAs, have soared over the last few years. One of the reasons for this, was a relaxation of the rules which was introduced by The Enterprise Act in April 2004. This Act brought sweeping changes to the old bankruptcy rules and made the process a lot easier. That is not to say that bankruptcy is the easy way out of your debt problems because it most certainly is not, it is merely the process that has been made easier.

The bankruptcy threshold is very low. Any of your creditors can make you bankrupt if you owe as little as £750 or more. However, it is not likely that a creditor would make you bankrupt for such a small amount unless you had significant assets that would be seized in bankruptcy, as the costs of the action are considerable for them.

If you have considered your position very carefully, you have little in the way of assets and there is no real prospect of you ever paying off your debts, then you can apply to the Court for voluntary bankruptcy. To declare bankrupt, you will need to contact your local County Court and ask them for a bankruptcy pack or you can now download the forms from the Insolvency Service website. The forms are quite involved and you need to sit down with all your statements and fill them in carefully. If you are having difficulty, you can ask you local Citizens Advice for assistance.

Once you have completed the forms, you need to make an appointment at your local County Court to present your petition. It is advisable to try to get an early appointment because the process will take you most of the day. On the date given, you will attend the Court with your completed paperwork and the required fee. These fees fluctuate quite a bit so it is best to check with the Court when you ask for your bankruptcy pack. At the time of writing, the total fees are £485 but if you are in receipt of benefits, you will be able to deduct the Court fee of £120.

Attending Court is the scary part for most people but there is no need to be frightened. The Court staff and the Judge will treat you respectfully and they will sympathise with your position. You are not there to be judged. Once the Court Clerk has processed your documents and taken your fee, they will issue you with your bankruptcy number, which will be something like No: 123 of 2008. You will then be asked to swear an oath on the Bible or affirm that you are making a statement of truth (if you object to the Bible). Then you will be taken to see a District Judge. This is not in open Court like you see on TV. It is held in the Judge's Chambers (his office) and the only people in there will be you and the Judge and perhaps the Court Clerk. You will be with the Judge for 3 or 4 minutes. The Judge may ask you one or two questions, such as if you are sure that you want to declare bankrupt and whether you have taken any advice on the matter. Once the Judge is satisfied, then he will make the order and you will be officially bankrupt at that time.

You will have to wait approximately 20 minutes or so for the Clerk to draw up the order and they will usually give you an envelope to take over to the Official Receiver's (OR's) office. You would normally go straight from Court over to the OR's office but each area is different and you may be asked to come back on another day. When you attend the OR's office, you will be questioned about the answers that you have given in your paperwork by the OR's examiner and the examiner will write out a narrative of everything that has lead up to your bankruptcy. You will be asked also to sign the Perjury Act and of course it is important to give truthful answers to the examiner. Again, this is not as sinister as it sounds, the examiner will be sympathetic to your situation. Remember that they see dozens of people in the same situation every week.

Part of the OR's job is to see whether you have any assets that can be sold for the benefit of your creditors. If for example there is equity in your property, this equity will transfer automatically to the OR when you are made bankrupt. However, any third party can make an offer to the OR to purchase your beneficial interest and if this happens, this effectively removes your house from the bankruptcy. All of your assets are at risk when you declare bankrupt and you may have to surrender anything with value, such as stocks and shares, savings, cars, expensive jewellery etc. However, contrary to popular myth, the OR's staff do not come round to your house rooting through drawers and cupboards and they can't take your bed and household furniture. The OR will rely pretty much on what you have stated in your statement of affairs. A word of caution here though, if you fail to inform the OR about an asset and it subsequently comes to light, even after your discharge, the OR can seize the asset and you may face charges under the Perjury Act.

The examiner will determine whether you will be asked to make a contribution to your bankruptcy from your income. This is known as an Income Payments Agreement (IPA) They will look at your income and your expenditure and anything left over is known as your expendable income. If this is the case. The OR will claim 50-60% of this (the percentage differs in each office around the country). If your expendable income is so low that they would not get at least £50 per month from you, then they would not impose an IPA.

If you can afford an IPA this will last for 36 months from the date of your bankruptcy, even though you will have been discharged earlier than this. The amount you pay can go up or down depending on any changes in your circumstances. If you are suffering hardship, the IPA can be cancelled altogether.

As a bankrupt you will come under a number of restrictions. You will not be allowed to apply for credit for more than £500 without declaring to the lender that you are an undischarged bankrupt and you will not be able to act as a director of a limited company. You can remain self employed, but you must not trade in any other name than the one that you were declared bankrupt in. A full list of restrictions will be explained to you by the examiner and they are listed on the Insolvency Service Website.

Once you are declared bankrupt, a bankruptcy notice will be placed in your local newspaper and you will be put on an NT tax code. This means that no tax will be deducted for the rest of the tax year. So, if you are made bankrupt in August, you will not pay tax until the following April. However, you do not get to keep this tax money and you should keep it aside for when the OR demands it from you. You will be discharged and free of the constraints of bankruptcy exactly one year after you were declared bankrupt. If your case is straight forward, there is a good chance that you could even be discharged early, within 6-8 months. You will not be notified of your discharge unless they are going to discharge you early but there is no need to ask for a certificate of discharge. You can obtain such a certificate if you really require one, but there is a charge for this, currently £60.

What About the Future?

Bankruptcies, CCJs and IVAs drop off your credit file 6 years after the end of the month that they were completed e.g. if you were declared bankrupt on 11th April 2000, the record would be deleted at the end of April 2006. It is the responsibility of the Registry Trust in London to maintain the public record and all records are deleted at the end of each month after 6 years have expired.