Topic 11: Dealing with Debt

Question 1

Dealing with debt:

Answer 1

Before they borrow money, people often use a budget to work out what they can afford to repay. Unfortunately, personal circumstances can change: people may lose their job or have their hours reduced, child maintenance payments might stop, and essential expenses such as rent or mortgage payments, food and energy costs might increase. Then borrowers will find it more difficult to repay debt

When people enter into borrowing contracts they are agreeing to a legal obligation. The consequences of not making repayments on time and in full are that the borrower may be unable to borrow elsewhere, or may only be offered products with high APRs. For example, Brandon signed a credit agreement when he applied for his credit card. He has been repaying the minimum amount each month and now owes £5,000. In the last six months he has missed two repayments. His credit card provider, BTT Bank, has raised the minimum payment for the next repayment to £500 and warned him that if he does not repay in full within 12 months it could take him to court to recover the money. Brandon wants to switch to another credit card with an introductory 0% APR on balance transfers but the provider he applies to rejects his application. He thinks this is because of his credit history

Question 2

There are several actions that people can consider when finding it difficult to repay debt, such as:

Answer 2

• getting free, impartial advice from debt organisations and websites
• using a budget to calculate what they can afford to repay and changing products or negotiating agreements with lenders to repay a smaller, affordable amount each month
• selling an asset such as a car or jewellery and using the proceeds to repay debts
• prioritising debts in terms of the consequences of not repaying and the cost of the borrowing (APR and fees)
• using formal debt management processes such as a debt relief order (DRO), an individual voluntary arrangement (IVA), bankruptcy, debt management plan or administration order

Question 3

Obtaining advice about debt:

Answer 3

Free, impartial advice is available for borrowers from a number of organisations, some of which are described below. There are other organisations that offer advice for a fee; however, paying a fee will reduce the amount of money people have to repay lenders

• MoneyHelper - is an independent organisation set up by the government to help people to understand financial issues and manage their money better. It is funded by a levy (compulsory charge) on the businesses that operate within the financial services industry. It provides advice online, over the phone and face to face
• StepChange Debt Charity - was established in 1993 as the Consumer Credit Counselling Service (CCCS) and changed its name in 2012 as part of its plans to raise awareness of its work in providing free debt advice. It provides online and telephone support to help people to create a budget and work out a plan to reduce their debts. Its website provides information on a range of issues such as student debt, the link between mental health problems and debt, and debt in retirement
• Citizens Advice - the Citizens Advice service is made up of a network of Citizens Advice bureaux in England and Wales, supported by the central Citizens Advice charity. The service provides free, independent, face-to-face advice on a wide range of issues and campaigns for consumer protection
• National Debtline - is a free, confidential and independent service providing personalised debt advice by phone, email or using the online tool My Money Steps, for people living in England, Scotland and Wales. It also provides a range of fact sheets and sample letters via its website

Question 4

People who are finding it difficult to repay debt may be able to increase their income by:

Answer 4

• claiming all the benefits they are entitled to
• taking on more work
• selling an asset

They may also be able to reduce some of their expenses by choosing cheaper options or buying less of a particular item. Increasing income and reducing expenditure is not always possible, however, depending on personal circumstances. The next step is for people to use their budget to work out a realistic repayment they can afford to make every month. People can do these calculations on their own or get free help from experienced advisers, such as Citizens Advice or the StepChange Debt Charity

Question 5

Once people know the repayments they can afford, they can consider:

Answer 5

• changing their existing borrowing products for ones that cost the amount they can afford in repayments
• negotiating with their existing providers to repay their debt at the level they can afford

People who decide to negotiate with their existing providers can approach the providers themselves, or ask a debt adviser to negotiate on their behalf

Question 6

Changing products:

Answer 6

If people have a good credit rating, they can consider switching credit card debt to a card that does not charge interest on balance transfers. Doing this stops the original debt growing and gives the borrower time to repay, but it only works if the cardholder makes no new transactions on the card and can afford to repay within the interest-free period

For example, Kelly has been making repayments of £150 per month on her credit card but still owes £5,000. She has stopped making new transactions on the card but is frustrated that the 19.9% APR means her debt keeps growing. Kelly has a good credit history so she applies for a 0% balance transfer to another card. The 0% deal lasts for 18 months. Kelly uses an online calculator to work out that, if she repays £300 per month, she can repay the full debt in 1 year and 5 months. This is three months earlier than if she had stayed with her first provider and saves her £813 in interest

People who are struggling to repay a loan may wish to consider extending the term of the loan. This is not always possible, but many providers would prefer that a borrower repay a loan in full over a longer period of time than did not repay it all, People in this situation need to approach their provider with a plan of how they can afford to repay the loan over a longer period of time. Alternatively, it may be possible for the borrower to take out a longer-term loan to repay the shorter one and so reduce their monthly repayments

Question 7

Some of the factors to consider when extending the term of a loan or taking out a longer-term loan to repay an existing shorter one are as follows:

Answer 7

• Repaying over a longer time, such as five years rather than three years, will reduce the monthly repayment but increase the overall cost of the loan
• There may be penalty fees for repaying the shorter loan early
• There may be set-up or arrangement fees for the new loan

For example, Eko has a loan with Canterbury Bank for £10,000. He is repaying it over three years at 12% APR and has a monthly repayment of £330. Over the three years he will repay £1,852 in interest. Eko is finding the repayments difficult so he approaches Canterbury Bank. They agree to change his term to five years. This means his repayments are £220 a month and he will pay £3,162 in interest. The loan is much more expensive overall; however, Eko finds the monthly repayments much more affordable.

Question 8

People with a number of different debts, such as an overdraft and several credit cards, may consider taking out a loan and using the funds to repay all the other debts; from that point they then have only one repayment to make each month, to the loan company. A loan used for this purpose is called a consolidation loan and it can make it easier for the borrower to repay by reducing the monthly cost. There are a number of factors to consider, however:

Answer 8

• Borrowers need to be very careful that they understand the full costs involved in the new loan. Some loan providers charge very high interest rates
• Borrowers must be able to afford the repayments on the loan if they are to clear their debts
• The overall cost of borrowing can be greater than on the individual borrowing products
• This approach will not work if borrowers continue to borrow on their overdraft and credit cards, as these debts will grow
• Borrowers need to be very careful about the type of loan they use because some products that are described as consolidation loans are mortgages secured on the borrower’s home. This means that the borrower could lose their home if they do not repay on time and in full

If people owe money on a number of different borrowing products, it is important that they prioritise the most expensive debt first so that they reduce the costs of borrowing as quickly as possible. The most expensive borrowing is usually credit cards and long-term overdrafts. If people have borrowed from payday lenders or doorstep lenders these products will be the most expensive

Question 9

Guaranteeing a loan:

Answer 9

Callie had been finding it increasingly hard to pay her bills each month. She approached her current account provider for a loan but her credit history is poor and she was turned down. She had thought about borrowing from a doorstep lender but was worried that the interest rates were very high. Instead, she found an online provider that would offer her a £3,250 loan, as long as she got a friend or relative to guarantee the loan repayments. The monthly repayment would be £158.57, over three years. Callie decided to ask her neighbour Rosie to act as guarantor

Rosie didn’t really understand what Callie was asking her to do but she didn’t want to say no to her so she went round to Callie’s house and completed the online application. A few days later the loan company rang her to check that she was willing to be a guarantor and to ask for her bank details. She didn’t understand the details about being a guarantor and she couldn’t understand why they wanted her bank details as the loan was for Callie, not her, but she provided them anyway. The loan company wrote Rosie a letter confirming the details of the call but she was busy when she received it and filed it away without reading it properly

Two months later, the loan company texted Rosie to advise her that Callie had missed a repayment and they would be debiting the payment from Rosie’s bank account. Angrily, she protested that the debt was nothing to do with her. She contacted a debt advice charity for help. After looking into the process the loan provider had followed, the adviser informed Rosie that she had entered into a binding contract and would be liable for any of the loan repayments that Callie missed for the term of the loan

Question 10

Debt management plans:

Answer 10

Sometimes people find that they have many debts and are struggling to repay all of them. For instance, they might have outstanding amounts on borrowing products and arrears (missed payments) on essential expenses such as rent or utilities. People in this situation can set up a debt management plan with a debt management company (DMC)

People pay the DMC what they can afford each month and the DMC divides this payment among the organisations that are owed money. This means the person in debt, known as a debtor, does not need to deal with the organisations they owe money to, known as their creditors

Debt management plans are offered free of charge by some charities such as the StepChange Debt Charity and Payplan. Most other organisations charge fees, which means the debtor has less money available to make repayments to the creditors

Question 11

The advantages of a debt management plan are that:

Answer 11

• the person in debt makes one affordable monthly repayment to the DMC, which is easier for them to manage
• the DMC arranges the plan with the person’s creditors and shares the monthly payment between them
• the person in debt has longer to repay what they owe

Question 12

The disadvantages of a debt management plan are as follows:

Answer 12

• DMCs only deal with non-priority debts such as repayments on loans and not priority debts, such as mortgage and rent arrears
• Creditors might still contact the person who owes them money and ask for further repayments
• Creditors do not have to accept a debt management plan. Many will, however, as they recognise they will be repaid, just over a longer period of time
• The debt will take longer to clear because the monthly repayments are smaller. However, many creditors will stop adding interest and fees to the debt as long as the repayments are being made

Question 13

Administration orders:

Answer 13

County courts in England, Wales and Northern Ireland can arrange repayment plans called administration orders. There are different arrangements in Scotland, which are described below

Administration orders apply to people who have less than £5,000 in unsecured debt and at least one county court judgment (CCJ) against them. People can apply to the court to have an administrative order issued. They then pay what the court decides they can afford to the court once a month, and the court makes repayments to their creditors

For example, Arthur applies for an administration order because he has a total debt of £3,750. His debt is all unsecured and comprises the maximum credit he is allowed on his overdraft and two credit cards. Arthur also has one CCJ for non-payment of a bill. The court decides that Arthur can afford repayments of £158 per month. He sets up a direct debit to pay this amount to the court every month and the court pays his creditors

Question 14

The advantages and disadvantages of an administration order are that:

Answer 14

• the person who owes money makes one monthly repayment that they can afford
• creditors are not permitted to contact debtors directly to ask for further payments and they are not permitted to add interest to the debt
• if the debtor cannot repay the debt in a reasonable time, the court can set an end date for the administration order. Creditors must write off any debt that is still outstanding after this time. The court agrees that the debtor will not repay all of the debt by issuing a composition order

The main disadvantage of an administration order is that the court decides what the debtor can afford to repay and this may mean that the debtor has to live on a very tight budget while the debt is being repaid

Question 15

Insolvency solutions:

Answer 15

People are insolvent if they cannot repay what they owe because their debts are greater than their assets (the property and goods that they own), or they cannot meet their financial obligations within a reasonable time of them falling due. Solutions for insolvency in England, Wales and Northern Ireland are individual voluntary arrangements (IVAs), debt relief orders (DROs) and bankruptcy. Scotland has different arrangements, which are described below

People who owe money can apply for insolvency solutions themselves. They should get advice before taking this step, however, to ensure that they understand all the implications of each solution and have chosen the most appropriate one for their circumstances. There are organisations that charge fees for this advice but people can get free, expert advice from Citizens Advice, the StepChange Debt Charity and other charities

Question 16

Individual voluntary arrangements (IVAs):

Answer 16

Under an IVA people make reduced, affordable repayments for five or six years and then their debt is written off. IVAs are legally binding arrangements on debtors and creditors

IVAs apply to people who have unsecured debts that are larger than the value of their assets. An insolvency practitioner (IP) negotiates the arrangement with the person’s creditors. As long as the creditors that hold 75% of the value of the debt agree, the IVA can proceed. If they do not agree, or the person who owes the money does not keep up their repayments, the person can be made bankrupt

Question 17

The advantages of an IVA are that:

Answer 17

• debtors make affordable repayments for a set period of time
• outstanding debt is then written off
• an IP (usually a solicitor or accountant) negotiates with creditors on the debtor’s behalf
• creditors cannot add any more interest or charges to the debt
• creditors cannot take court action against the debtor

Question 18

Debt relief orders (DROs):

Answer 18

Debt relief orders (DROs) enable people to write off their debts if they are unable to repay them after 12 months. DROs only apply to people who:
- owe less than £30,000 in unsecured debts (DROs do not apply to student loans)
- are not homeowners
- have no more than £2,000 in assets (although they can own one vehicle worth up to £2,000)
- have less than £75 a month left over after they have paid their living expenses

Debtors must pay £90 for a DRO and apply to the courts through an authorised adviser. Their debts are frozen for 12 months so creditors cannot add any interest or charges to them. Creditors are also not permitted to contact the debtor to ask for payment during this time. If the debtor’s ability to repay has not changed after 12 months, their debt is written off

Question 19

The advantages of a DRO are that:

Answer 19

• household goods and tools of the trade are not included in the asset calculation
• it gives the debtor time to change their personal circumstances if they can, for example by finding work
• debtors will not be pressurised to repay during the 12-month period and their debt will not grow
• it is a cheaper insolvency solution than bankruptcy for people who have very low incomes

Question 20

The disadvantages of a DRO are that:

Answer 20

• it stays on the person’s credit history and a public register and will make it difficult for them to borrow money during this time
• the cost of £90, although lower than other options, can be difficult for people on very low incomes to pay

Question 21

Bankruptcy:

Answer 21

Bankruptcy is a court order that means a person’s assets are shared between their creditors who write off the remaining debt. An official receiver is appointed who can sell the person’s assets and use any savings and the debtor’s income to repay creditors. People can apply to become bankrupt themselves, or one of their creditors can apply to make them bankrupt

The costs of going bankrupt vary across the UK. In England and Wales there is a bankruptcy fee of almost £700 and in Northern Ireland the fee is slightly lower. People on low incomes and benefits are charged between £100 and £150 less in England, Wales and Northern Ireland because court fees are waived

Question 22

The advantages of going bankrupt are that:

Answer 22

• debtors do not deal with creditors directly
• debts can be written off in 12 months
• debtors keep certain possessions, such as household goods, and an amount to live on
• when the bankruptcy is over, debtors have a fresh start
• creditors have to stop most types of court action to recover their money

Question 23

The disadvantages of bankruptcy are as follows:

Answer 23

• There are costs involved in the bankruptcy process
• Debtors cannot apply for more credit while they are bankrupt
• Debtors can only use basic current accounts because they cannot go overdrawn
• The record of a bankruptcy remains on the debtor’s credit history for six years after the start of the bankruptcy. This makes it difficult for them to obtain credit during these six years
• Many of the debtor’s assets have to be sold to repay their debts, including their home, car and any luxury goods
• People who have been declared bankrupt are barred from certain occupations - some jobs within financial services for instance cannot be carried out by a person who has been declared bankrupt. In these circumstances, the debtor will lose their job
• If the debtor owns a business, it is likely to be closed down and the assets sold
• Details of the bankruptcy are published and may be reported in the media
• Some debts, such as student loans and court fines, are never written off
• If the court considers that the debtor never intended to repay their debts or did not co-operate with the official receiver, it can issue a bankruptcy restriction order that lasts for 15 years

Question 24

Debt Arrangement Scheme in Scotland:

Answer 24

The Debt Arrangement Scheme is run by the Scottish government and is similar to a debt management plan. People must owe money to one creditor or more and must be able to afford some repayments to be eligible for a debt payment programme under the Scheme. They make payments to the programme, which are then shared among creditors

Question 25

Trust deed in Scotland:

Answer 25

A trust deed is similar to an individual voluntary arrangement (IVA). An insolvency practitioner helps people who are insolvent to make repayments they can afford and after four years any outstanding debt is written off

Question 26

Minimal asset process (MAP) bankruptcy in Scotland:

Answer 26

The MAP bankruptcy was introduced in Scotland on 1 April 2015 to replace the low income low assets (LILA) option. MAP allows you to write off debts that you are unable to pay off in a reasonable time. You pay a fee and, if you are eligible, your debts may be written off in around six months

To be eligible, you must live in Scotland and prove that:
- you are on a low income
- your debts are between £1,500 and a specified higher amount, which is usually £17,000 but was raised temporarily to £25,000 due to Covid-19
- you are not a homeowner
- any vehicle that you own is worth less than £3,000
- your assets are worth less than £2,000
- you have not been made bankrupt in the last five years

If you are made bankrupt via MAP, you remain on a public register for five years (StepChange, 2022)

Question 27

Sequestration in Scotland:

Answer 27

Sequestration is the term for bankruptcy in Scotland. A person who owes more than £3,000 and has not been bankrupt in the last five years can apply voluntarily. A creditor can usually apply for a debtor’s sequestration if they are owed more than £3,000 and have got court judgments for payment against the debtor, but the amount was raised to £10,000 during the Covid-19 pandemic. The court actions are called a decree and a charge for payment, and a summary warrant. Sequestration costs £150 and usually lasts for 12 months

In the sequestration process, the individual transfers their assets to a trustee or insolvency practitioner, who manages the sale of the assets to pay creditors