There is a general misconception that any form of debt reorganisation plan will ultimately strip an individual of all of their assets and all of their income.
Before we take a look at the various ways in which you can write off debt you can’t afford to pay back, it is worth reminding ourselves of the concept of debt management.
The idea is simple, those struggling to cover their financial liabilities will be asked to pay what they can afford and also liquidate surplus assets. This may prompt the question, why not take everything?
Looking to the Future
If you think about it, for example somebody struggling to pay their debts enters an arrangement and their vehicle is taken off them. This may have been their only way to get to and from their place of employment and could put future employment in jeopardy.
If the individual is not able to work then their income will be affected and their financial prospects would likely deteriorate. Therefore, debt management plans, whatever form they take, have a very clear target; the individual will pay what they can afford and where applicable debts will be written off.
This action ensures that creditors can draw a line under problem debts, write them off (with potential tax relief) and focus on other areas of their business.
The truth is that in many cases there is no point in pursuing an individual for many years if they don’t have the ability to pay. There are numerous options when it comes to debt management some of which involve debt being written off.
Individual Voluntary Arrangement (IVA)
The best way to describe an IVA is a formal and legally binding agreement between an individual and their creditors. These arrangements are approved by the courts and therefore there are repercussions if they are not adhered to.
All IVAs are managed by an insolvency practitioner who will present a summary of your financial situation, income and assets to your creditors. This will also include a repayment plan on which creditors will be given the opportunity to vote.
In order for an IVA to be approved, creditors representing at least 75% of the value of outstanding debt must vote in favour.
Advantages of an IVA
An IVA is a way of maintaining a degree of control of your finances, by agreeing reduced monthly payments, thereby avoiding bankruptcy proceedings.
Under this type of arrangement you will make one payment each month to your insolvency practitioner which will be distributed to creditors on a pro-rata basis, with administration fees also taken from this payment. Once an IVA has been agreed, creditors are not allowed to take legal action and there are strict rules regarding communication.
All interest and charges relating to your debts are frozen from day one of an IVA.
A traditional IVA will last five years after which, assuming all agreed repayments have been made, all remaining debts will be written off.
Disadvantages of an IVA
Unfortunately, not all types of debt can be included in an IVA for example court fines/penalties. As you would expect, agreement of an IVA will result in an adverse impact on your credit rating and limit access to finance for at least six years.
Failure to maintain agreed repayments under an IVA could see interest and charges backdated and the potential commencement of bankruptcy proceedings.
Any increase in your income, or receipt of additional funds/assets, during your IVA, could be claimed by your administrator and paid to creditors as a windfall payment.
Debt Management Plan (DMP)
In theory a Debt Management Plan is an informal direct arrangement between a debtor and their creditors which includes a plan to pay back as much as they can afford.
In reality, the vast majority of debt management plans are arranged by debt management companies who can advise individuals about the most appropriate course of action to take.
As we move through the various options when looking to repay debt and write off any remaining funds, you will notice there is an array of different choices to make.
It will depend upon an individual’s circumstances as to which type of arrangement may be best for them.
Advantages of a DMP
The main advantage of a DMP is the fact that assuming your creditors accept it, you will only pay back what you can afford. It is also possible to include general household bills in this arrangement although you will need to ensure payment of future bills on time.
If your creditors see that you have paid back as much as you can over a prearranged timescale, there is the possibility that the remaining debt will be written off.
Disadvantages of a DMP
You will find that there are advantages and disadvantages to any debt management arrangement because there are obvious consequences when reneging on your financial liabilities.
Some of the main disadvantages of a DMP include an extended impact on your credit rating which will limit access to credit for at least six years. As this is an informal arrangement creditors are not bound to join the arrangement which can complicate matters.
Unfortunately, some of your creditors will continue to contact you and could take legal action in their own right.
Debt Relief Order (DRO)
A DRO is a type of debt management tool which is focused on those who have relatively low level debt, few assets and minimal if any income.
The idea is very simple, your debt repayments and interest will be frozen for 12 months after which time your situation will be reviewed.
If there is no realistic hope of recouping outstanding debts then they will simply be written off. In the event that your financial situation has improved then you may be asked to contribute towards outstanding debts.
This may involve switching to an alternative debt management arrangement but this will be shaped by the individual’s financial outlook.
Advantages of a DRO
As this type of arrangement tends to involve relatively low level debts, with minimal income/assets available, it can be concluded fairly quickly. While this is a formal arrangement there is no need for the debtor to attend court.
During the initial 12 month period when debts and interest are frozen, your creditors are not allowed to contact you. In the event that your circumstances do not change over the 12 month period, or perhaps worsen, all of your debts will be written off.
Disadvantages of a DRO
This type of arrangement is more suited towards unsecured debts and as a consequence homeowners are unlikely to be considered for such a scheme.
A DRO is only applicable for debts less than £20,000 and there is a relatively small non-refundable arrangement fee of around £100.
As with the majority of debt management arrangements, details of a DRO will appear on your credit file and public register.
Bankruptcy (also known as sequestration in Scotland) is for many a last resort when struggling to fulfil their financial obligations. Unfortunately, even the term bankruptcy creates a certain stigma which has seen many people avoid this option at all costs.
In reality, for many people bankruptcy may be their only option and the only way in which they can draw a line under their financial troubles and start again.
Ultimately, while bankruptcy should eventually lead to the writing off of unpaid debts there are still various issues to take into consideration.
Advantages of Bankruptcy
Once a bankruptcy arrangement has been put in place creditors will not be allowed to contact/harass the individual. They won’t be able to take any legal action as this legally binding arrangement will cover all of an individual’s debts.
While all income and assets will be reviewed, consideration will still be given to assets such as a vehicle so the individual can maintain employment.
Disadvantages of a Bankruptcy
As you would expect, in the event of a bankruptcy the insolvency service will have access to the individual’s assets and income. They will look to liquidate as many viable assets as possible which may include property.
Any change in circumstances must be immediately reported to the insolvency service which may adapt, extend or terminate a live bankruptcy arrangement.
Your credit rating will be impacted for a minimum of six years from the start of the bankruptcy arrangement which will limit access to credit.
While many people see bankruptcy as the “nuclear option” for many of those going down this route it is the only option.
However, if an individual was found to be dishonest with regards to the disclosure of assets and income during a bankruptcy arrangement there would be consequences.
It is the ultimate opportunity to draw a line under previous financial troubles but those involved must act to the letter of the law and the spirit of the arrangement.
Offer in Full or Final Settlement
Arranging an Offer In Full Or Final Settlement of outstanding debts may well involve delicate negotiations with your creditors. This type of arrangement tends to occur where an individual, with significant debts they are unable to service, is in receipt of a lump sum payment.
Even though the lump sum payment does not cover their debts in full it would likely contribute to a large element of their financial liabilities. In the event that future repayments were in serious doubt it is not inconceivable that some creditors may accept part payment in final settlement.
This would allow them to draw a line under the situation and focus on other areas of their business. There is a very real cost when chasing debts month after month or year after year!
Benefits of an Offer in Full or Final Settlement
As the offer is made on the proviso that additional debts are written off this allows individuals to draw a line under their financial troubles. It also ensures that creditors are not able to take legal action further down the line to retrieve any outstanding debts.
There is no limit on the type or size of debt involved in an Offer In Full Or Final Settlement.
Disadvantages of an Offer in Full and Final Settlement
One of the main disadvantages of this arrangement is that missed repayments will still appear on your credit file prior to the arrangement being agreed. Indeed it is also likely that the informal arrangement would be mentioned on your credit file to “warn” other third parties.
As a consequence, there will be a short to medium-term impact on your credit rating which will limit access to additional funds. Creditors may on occasion decide to enter into a monthly payment arrangement funded by the lump sum payment.
This ensures that the debts remain live and in the event that the individual’s financial scenario was to improve they would stand a greater chance of obtaining additional funds – thereby limiting their debt write-off.
An Administration Order involves a direct application to a County Court to put in place a regular monthly repayment plan. The court will review the individual’s financial circumstances, debts owed and ultimately their ability to pay. If successful, the court will put in place a repayment plan and collect monthly payments.
These payments will then be distributed on a pro-rata basis to creditors over a term which is also determined by the court.
Advantages of an Administration Order
Once an Administration Order has been approved by the courts, all creditors in the agreement are barred from contacting the debtor.
While there is no standard duration for an Administration Order, they don’t normally last more than three years.
When the Administration Order is nearing the end, the courts may rule that any outstanding debt is written off and the individual is debt-free.
Disadvantages of an Administration Order
Only individuals with debts of less than £5000, owed to at least two separate parties, can pursue an Administration Order. At least one of the debts must be a County Court/High Court judgement and the debtor must have at least some spare income each month to contribute.
All assets and savings would be taken into account when looking to settle outstanding debts. Also, reference to the Administration Order will appear on your credit file and remain so for at least six years from the initial ruling.
Broadly speaking, a Trust Deed arrangement with regards to debt management is the Scottish alternative of an IVA. This is a formal agreement between an individual with significant debt, who is unable to honour repayments, and their creditors.
It is probably best described as somewhere between a debt management plan and bankruptcy, giving the individual the opportunity to repay part of their debt and potentially have the rest written off.
As the term suggests, a trustee is appointed to administer the arrangement and will ensure that all parties are abiding by the agreement.
Advantages of a Trust Deed
As we touched on above, a Trust Deed is an arrangement whereby an individual only pays back what they can afford over a four-year period (although this can be extended).
There are many different types of debt which can be included such as store cards, credit cards, overdrafts and personal loans.
As long as the debtor fulfils their side of the arrangement all remaining debts will likely be written off after the four year period.
Disadvantages of a Trust Deed
Unfortunately only unsecured debts can be included in a Trust Deed arrangement thereby leaving an individual open to additional action regarding secured debt.
To gain “protected status” a Trust Deed proposal would need acceptance by at least 75% of creditors based on overall debt. As with most debt arrangements, Trust Deeds are a matter of public record and will also appear on your credit file.
A failure to adhere to the terms and conditions of a Trust Deed would risk termination and possible bankruptcy proceedings. Unfortunately, those with significant equity holdings in their home may be forced to remortgage or sell.
Minimal Asset Process
There are some anomalies between England/Wales and Scotland, one of which is a Minimal Asset Process (MAP) – similar to a Debt Relief Order in England and Wales. In effect this is akin to bankruptcy proceedings but targeted at those with relatively modest debts, low income and very few if any assets.
The terms have recently been changed by the Scottish government, increasing the upper limit from £17,000 to £25,000. The idea is simple, rather than attempting to obtain payment from an individual who is clearly not able to raise the required funds, this draws a line under their financial woes and allows them to move on.
Advantages of a MAP
The advantages of a MAP are relatively straightforward in that the individual cannot be contacted by their creditors and their debt will be written off, normally six months after the quasi-bankruptcy is approved.
The debtor will be able to keep a vehicle worth less than £3000 and other assets worth less than £2000 – as long as one asset is not worth more than £1000.
The process is relatively quick and simple and creditors participating in the arrangement are not able to chase for outstanding debts at a later date.
Disadvantages of a MAP
There are a number of issues to consider with regard to MAPs which include the fact that homeowners are not eligible for the scheme. Also, those who have experienced sequestration (Scottish equivalent of bankruptcy) within the last five years can’t apply.
As you would expect, any form of debt management arrangement will impact your credit file for a minimum of six years.
There’s also the potential that a MAP may impact your bank account, employment, place of residence and self-employed status.
As we touched on in the early part of this article, while individuals who renege on debt repayments will see their credit rating impacted, creditors may be open to the idea of writing off debts in some circumstances. Creditors may be sympathetic if for example you were terminally ill or permanently unable to work.
Some of the issues which will need addressed include:-
- Demonstrate why it was unlikely you would be able to make any repayments going forward
- Clarification you have no meaningful assets which could be sold
- Provide evidence to show why it is not worthwhile pursuing repayment of debts
While negotiated write-offs are not the most common type of debt management activity, on occasion they can be the only meaningful option.
It is not so much as creditors are simply willing to write off these debts but the fact that any time spent chasing in the future would not be cost-effective.
It is also worth noting that there are potential tax offsets for businesses when debts are written off.
Making the Right Decision
It is important that you take professional advice regarding your finances if you are having trouble making debt repayments. Each of the individual arrangements mentioned above is relevant to particular parties in particular scenarios.
For example, somebody with assets and a constant flow of income would be unlikely to be granted a bankruptcy application. Looking at this from a creditor’s point of view, people in this situation have assets and income so at worst they can contribute.
It is not uncommon to see the financial status of individuals change over the duration of a debt management plan.
At this point it is worth reminding ourselves that any material change in your finances must be reported to those schemes where there are administrators.
It is also worth noting that those who are wilfully dishonest with regards to disclosure of their income and assets may suffer serious consequences.
The whole concept of debt management is to ensure that those who can at least part repay outstanding debts may do so. Those with assets may be required to liquidate them and put funds raised towards their debts.
On the flip side of the coin, it makes no sense to pursue those who have limited income and negligible assets on a long-term basis.
As a consequence, the English/Welsh and Scottish governments all support akin to quick-fire bankruptcies for those where there is little chance of an improvement in their finances.
Those appointed to administer various debt management options are brought in to take an unbiased view of the situation. They are also able to manage this on a hands-off basis and ensure that all parties are treated fairly.
The terms and conditions of any arrangement will be set out clearly, the individuals made aware of their obligations and creditors made aware of their responsibilities.
The long-term goal is to reach a situation where debts are repaid in full or in part, then written off, or simply written off where the individual is unlikely to ever be in a position to resume repayments.
How Can Love Debt Free Help?
Here at Love Debt Free, we have partnered with some of the UK’s leading Debt help companies.
They have already helped thousands of people reduce and manage their debts, and they can do the same for you.
Choosing an independent adviser means they won’t recommend a scheme unless they are sure it is in your best interests. Their advice is also regulated by the FCA, which gives you an additional layer of protection.
If you would like to speak to one of these debt help companies, click on the below and answer the questions.