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Bankruptcy – The Full Facts

The number of personal insolvencies has soared to record levels. There were 15,394 in the second quarter of 2005, marking an increase of 12% on the previous three months and a staggering 37% on the same period last year. The latest figures are due out on Friday – and nobody is expecting a decline.

Mike Gerrard, a personal insolvency specialist at Grant Thornton, says: “In the first six months of the year, there were about 30,000 personal insolvencies, an equivalent of more than 160 every day. I believe there is every likelihood of more than 60,000 before the end of the year, which would be double the number three years ago. To put it into context that’s almost like filling Manchester United’s ground at Old Trafford.”

The rise in bankruptcies coincides with a sharp increase in house repossessions. Court orders made to repossess properties were 66% higher over the past 12 months at 19,687 in the third quarter, the highest level since the first quarter of 1996.

David Stubbs, an economist at RICS, says: “The main reason behind the upturn in repossession activity is the rise in interest rates that began at the end of 2003 and continued to August of last year. These rises have increased mortgage interest payments by a substantial margin over the past year.”

But the Council of Mortgage Lenders (CML) is keen to snuff out any talk of a crisis. Sue Anderson of the CML says: “The figures show the number of orders for possession granted by the courts. However, these figures are much higher than the number of actual repossessions. For example, in the first half of this year there were 32,366 orders made, but only 4,640 actual repossessions.”

No wonder the CML is on the defensive, when some experts believe its members are at least partly to blame. Melanie Bien of Savills Private Finance, a mortgage broker, says: “Banks and building societies have traditionally based their mortgage calculations on your salary, so you were limited to four times a single income or two and a half times a joint income. But many have now switched to relatively woolly “affordability” calculations. Unfortunately, some people will borrow as much as a lender is willing to advance and this may have led them to take on more debt than they could afford.”

And it might be difficult to repay that debt if you plumped for a cheap two-year fix a couple of years ago. Philip Cartwright of broker London & Country Mortgages says: “Lots of people snapped up cheap fixed rates in 2003. When the deals expired earlier this year, the interest rates on some mortgages would have doubled.”

Mortgages are only part of the consumer debt story. If you include personal loans, credit and store cards we owe a grand total of about £1.1 trillion. We are, it seems, particularly fond of credit cards. UK consumers hold 66m credit cards – five times the European average.

Gerrard says: “Last year we were seeing people with loans, credit and store card debts in the region of £50,000. Now it’s anything in the £50,000 to £100,000 bracket. It is clearly not surprising that individual bankruptcies are continuing to rise, nor that house repossessions are also becoming more commonplace after lying relatively dormant since the late 1980s and early 1990s. The problem rests squarely on excessive credit and store card use, personal loans, and often unsustainable champagne lifestyles.”

Can bankruptcy really help if you are a victim of the credit boom? A recent change in the law brought in the “quickie” bankruptcy: you must now be discharged of your status as a bankrupt after a maximum of 12 months. But bankruptcy is not an easy way out.

You file a petition for bankruptcy with the local county court and it costs about £400.

But you must then hand over all your assets to an official receiver or a licensed insolvency practitioner. You basically lose everything. The receiver sells your assets to clear the debts, plus interest, and cover any costs – and assets include your house. Say you owe £50,000 and your home is worth £250,000 with a mortgage of £150,000. The receiver could sell the property to release the £100,000 of equity to clear the debts and settle any professional fees. If the house is in joint names, the receiver would be entitled to only half the equity, but the sale could still be pushed through.

Your best hope is that your spouse or other family member would buy your share of the property. They would still have to hand the money over to the receiver, but at least you would be able to stay in the home.

If you are declared bankrupt, your bank account will also be frozen and you might be forced to pay a regular amount each month from your income.

Mark Allen of Grant Thornton says: “Bankruptcy is not a soft option. Your debts might be written off, but you lose all your assets. I would really only recommend it to people who are overwhelmed by debt, but have no assets or income.”

The quickie bankruptcy does not really make it any easier, either. You might not carry the bankrupt’s label after 12 months, but chances are you will still bear the scars. Credit reference agencies, for example, will keep a note of your bankruptcy on their records for up to six years. So you might still find it hard to arrange a mortgage, take out a loan or even open a current account.

The most common alternative to bankruptcy is to agree some sort of payment schedule with your creditors. It can be informal, or you can agree an Individual Voluntary Arrangement (IVA) through an insolvency practitioner. The advantage of an IVA over bankruptcy is that you do not have to surrender all your assets to a receiver, or bear the stigma of a bankrupt. The debt is also frozen.

You might, for example, have debts of £50,000 and agree to pay £25,000 up front, perhaps by withdrawing equity from your home. You might then arrange to pay £200 a month over the next five years in full and final settlement, so you would eventually repay a total of £37,000. Allen says: “You don’t have to clear your debts in full, but you have to prove you are willing to meet your creditors at least part way. If you are under threat of house repossession, an IVA can also be a good way to safeguard your home.”

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