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Can going bust solve the debt crisis?

More and more people are getting caught up in our ballooning debt crisis. One person goes bust every minute of the working day and home repossession applications show the biggest increase since the housing crash of the early 1990s.

The recent rise in interest rates can hardly have helped, especially as it followed record fuel bills and council tax payments.

More than 26,000 people became insolvent between April and June, according to the Insolvency Service. The figure brings the total this year to nearly 50,000. The number of insolvencies is expected to top 100,000 by January.

The Council of Mortgage Lenders reports that repossessions in the first half of the year were up by 76% to 8,140 – and further increases are expected.

Banks are keen to play down the repossession figures, and it’s true the numbers are still relatively low. But they are an indication that ordinary families are beginning to struggle with debt.

Jump in insolvencies

The jump in the number of insolvencies is largely attributable to the rise in popularity of Individual Voluntary Arrangements (IVAs) – a sort of bankruptcy lite. The number of people entering into IVAs has rocketed by a record 153% to 11,105 in the second quarter of this year.

Cases of bankruptcy, on the other hand, dropped by 3.3% to 14,915 in the three months to June.

Mark Sands, director of insolvencies at KPMG, the consultancy, is not optimistic about the future. He says: “We are entering an era where personal insolvency is going to be an accepted part of everyday life. In the past few years there has been a complete change in people’s attitude to credit.”

We certainly seem happy to pile on the debt pounds. At the last count, we owe about £1,200 billion, or more than £1 trillion.

Banks must take their share of the blame for aggressive marketing and the supply of easy money. But we are also more comfortable than previous generations with the idea of borrowing rather than saving to fund our lifestyles. You want a new car? Sure, just take out a loan.

We also seem to be more relaxed about paying back our debts. The banks are bumping up their bad debt provision – and it’s no wonder when insolvency seems an easy option for many people. But is it? Or are companies pushing us to go bust for their own interests?

How an IVA works

An IVA is a formal arrangement to pay off a portion of your debt over an agreed period – usually at least 25% over three to five years. You can only enter an IVA if you owe at least £15,000 to two or more lenders and the typical debt is £46,000. The interest on the debt is frozen and the debtor is declared debt-free at the end of the period.

An IVA must be set up by an authorised insolvency practitioner who will agree a schedule of payments with your creditors. The practitioner will also charge a fee. The fees vary widely but start at about £4,000. You might have to pay the fee upfront, although some firms will let you spread the cost over monthly instalments.

The number of IVAs could rise further still with plans to introduce the Simple IVA within the next 18 months. If you draw up an IVA, you must get agreement from the creditors who are owed at least 75% of the debt. A Simple IVA will mean you need agreement only from the lenders who are owed 50%.

Some experts fear that debt companies are pushing people into IVAs because they earn high fees. Paul Latham, finance director at Debt Free Direct, an insolvency advice group, says: “There are people in our industry who are not giving the best advice either for the debtor or the lender. Some advisers charge the debtor upfront to arrange an IVA, which is not refunded if no agreement is reached. That should be banned.”

You should beware companies that promise to cut your debts by 75% or so. Such promises can be misleading because the creditors are unlikely to agree to such a chunky reduction in the amount you owe.

It is also quite common for an insolvency practitioner to put together unrealistic proposals – perhaps suggesting that the debtor makes monthly payments that he or she cannot afford. So the IVA fails. The client is then back to square one, but the firm still pockets its fee.

Debt advice

Consumer groups are worried that debt companies are pushing IVAs as an easy way to clear your debts. The Consumer Credit Counselling Service, for example, recommends IVAs only in about 3% of cases. Most people are advised to draw up an informal debt management plan to pay off the debt over time.

Beccy Boden Wilks of National Debtline says: “People considering an IVA should seek impartial advice, often available free, so they understand the implications and are aware of the alternatives. They should also check their insolvency practitioner is regulated – and ask about the fees.”

An IVA does not carry the stigma of bankruptcy and is more flexible, because you do not have to hand over all your assets to a receiver. You can negotiate with your creditors so you might, for example, be able to save your home from repossession.

But you cannot walk away from your debts and it will certainly affect your credit rating. So you might find it difficult or expensive to get any kind of loan in the future.

When you are dealing with debt, there are no soft options.

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