A Debt Management Plan (or DMP) is an informal agreement with creditors reducing the monthly repayments that they accept so that these fit within an affordable budget. With the significant increase in the number of IVA applications over the past 2-3 years, Creditors seem more and more keen for people to use a DMP to resolve their debt problems. I have seen a number of creditors hard sell the DMP solution suggesting that it is far better for the individual than an IVA. However, who’s best interests do the creditors have at heart?  

 When looking at a DMP it is essential to consider not just the short term gain but the long term result. If used properly, it is true that a Debt Management Plan will get immediate debt payment problems under control and bring an end to robbing Peter to pay Paul. However, the DMP will often not ultimately resolve the debt problem.  

The main issue lies in the fact that if you use a DMP, you are still obliged to pay back 100% of the debt that you owe. Clearly with reduced monthly payments, the time it will take to repay back what you have borrowed will be significantly extended. Simply dividing the total amount of debt you owe by the total monthly payment agreed in a debt management plan will give you the number of monthly payments you will have to make. In many cases this will be over 8-10 years.

Scrimping, saving and living within a tight budget to repay your debts is not easy. It is bad enough facing this for 5 years in an IVA, however, if your are looking down the 10 year path of a Debt Management Plan, many are just unable to comprehend it. This prospect just does not offer any light at the end of the tunnel. And with human nature being what it is, if we can not see progress, we are all too likely to give up. This is why that majority of Debt Management plans fail after their 1^st year. 

But if they have such a high rate of failure, why are the banks in favour of Debt Management Plans? One school of thought is that banks are allowed to treat Debt Management Plans more favourably when considering bad debt provisioning on their balance sheet where as debts within an IVA must be written off 100%. If this is the case, then there is a clear corporate benefit from pushing people down the DMP route and steering them clear of an IVA. But surely, what is needed here is a solution which is ultimately going to resolve an individual’s debt problem rather than one which seems to serve the creditors best interest of showing higher profits?

With the financial news filled with the US subprime mortgage crisis, around the globe economists are holding their breath, waiting to see what the impact will be on domestic financial markets. Already, hedge funds are reported to have taken striking losses, and bankers and investors are growing increasingly jittery – in an uncertain lending environment, cash is king.

While the damage to stock markets and large scale investors is currently being well documented, further down the financial food chain ordinary mortgage owners and those struggling with personal debt may be fearful that their creditors may soon become a lot less forgiving and less flexible.

Most IVAs require remortgaging in the final year in order to raise equity for creditors – by their very nature, anyone applying for a mortgage whilst in an IVA qualifies as subprime, the very area of mortgages that has the stock markets running scared and that could be facing potential rate hikes.

However, there is no need for panic. The housing market in the UK is stronger than it is in the US; with the property itself as viable financial collateral due to rising house prices, we are unlikely to see the same difficulties in securing a mortgage in the UK. Lenders have not been as rash, house prices are up, and the market is more stable.

Debtors may be concerned at having to pay their monthly sum to their creditors while simultaneously paying for a subprime mortgage at a disadvantageous rate, but there should be no difficult overlap period. In an IVA, the equity released from a remortgage is paid as a final lump sum to conclude the IVA. Even if the subprime remortgage has a higher rate of repayment than the previous mortgage, the debtor will no longer be paying all of their disposable income into an IVA, and can use this money to support the new mortgage.

Some debtors may feel they have gone from the frying pan to the fire – having been living on a tight budget for five years and directing their disposable income to their creditors, they may feel that this money is now going to an estate agent instead. But mortgages can be renegotiated – after two years or so, a more advantageous mortgage can be established. After five years in an IVA, some debtors may lose heart at the thought of more years of careful spending, but they will not be trapped in a subprime mortgage indefinitely.      

It is too soon to say what the full effects of the current financial and subprime crisis will be, but for the moment the effect on those in IVAs should not be significant.     

At the beginning of August, the official 2007 Q2 insolvency figures were released by the Government’s Insolvency Service. The headline figure was that overall the total number of people declaring insolvency (bankruptcy or IVA) had dropped on the previous quarter and only increased slightly on the previous year at 4%. Certainly not the double figure increases that we have seen in recent quarters and that some were predicting. 

But why is this? I do not believe that people have suddenly learned how to better manage their money and that personal debt problems have magically started to disappear overnight. Rather, the figures only record official insolvency – those who have formally been declared bankrupt or entered into an IVA. The figures do not include people how are struggling with debt but are trying to resolve this through an informal Debt Management Plan. 

A Debt Management Plan (or DMP) allows the person in debt to reduce the payments they make to each creditor to fit within a budget they can afford. However, the massive downside is that all the debt still has to be prepaid which will take many years without any legal protection from additional interest or charges. These plans are currently in favour with creditors. But why? Clearly a creditor will have the chance to get all their money back. However, the real reason is that the debt is officially still a debt and therefore an asset on the balance sheet. It does not have to be written off as it would with a bankruptcy of IVA. 

Banks are putting huge pressure on people in debt to choose the DMP route rather than a formal IVA. This means that individuals with crippling debt problems are having their pain prolonged with no light at the end of the tunnel. The end result – government figures for debt look better and banks get their own way again. However, it’s the people in need of help who are being overlooked and pushed deeper into the underworld of unrecorded debt.

Banks Beware - Bankruptcy seems the Easy Option for the Young 

It strikes me that over the past 20 years credit is part of our culture. Buying goods with store finance or on credit cards is no longer frowned upon and almost positively encouraged. Unfortunately, hand in had with this culture of buy now and pay later comes the inevitable problem of debt.

People of all ages may fall into debt problems. However it is the young who perhaps the banking sector need to be most worried about.  

I have had many conversations with young people between the ages of 20 and 25 years old who are in serious debts of between £15,000 - £40,000 usually from credit cards and personal loans. When they understand the options open to them for dealing with these problems they realise that Debt Management Plans and IVAs will mean repaying the money they owe over a significant period of time normally while having to stick to a very strict financial budget. On the other hand by declaring bankruptcy, if monthly payments are required at all, these will almost certainly only last for 3 years.

It is clear that most young people can go through the bankruptcy process with impunity. Recent increases in the cost of housing have meant that young people have not been able to get on the housing ladder. They therefore have no assets which would normally be taken from them in bankruptcy. In addition, young people see banking institutions posting huge profits and do not feel any sense of guilt if they find themselves in a position where they are unable to repay their debts. Therefore why make the effort to try and repay required for an IVA or Debt Management Plan.

In my experience, the majority of young people are not concerned with any stigma attached to bankruptcy and more and more they are choosing this route to deal with their debt problems.

The banking industry should be aware of this situation and think carefully about their lending criteria for younger people.

The Insolvency Service is proposing to launch the Simple IVA, or SIVA, in Spring 2008. They’ve spoken with IPs, creditors, and debt counselling services, and have come up with several modifications to the existing IVA, in order to give a simpler option for those in a debt crisis recognising that the IVA was originally introduced largely to serve the needs of professionals, self-employed traders and company directors whose financial affairs were deemed to be more complex.

There are plenty of sensible changes. The maximum debt level will be set at £75,000, with no minimum requirement. This opens the SIVA up to the majority of people with personal debts – approximately 80% of them will be eligible for a SIVA.  At creditor variance meetings (which could potentially be held by postal or faxed vote rather than in person), a 50.1% vote would confirm acceptence, rather than the current 75% requirement. This will stop creditors who are owed more than 25% but less than 50% of the total debt having an unreasonable degree of influence. The procedure will not be available for self-employed traders or anyone with debts to H M Revenue & Customs, whose affairs are deemed to be more complex.

Creditors, who currently have the full term of an IVA to lodge a claim, will only have 90 days within the proposed SIVA. This is good for the debtor, and the insolvency practitioner who will be able to commence repatriation of monies to creditors at a much earlier stage. Claims will have to be thoroughly investigated before the SIVA is begun. If the SIVA fails, it cannot be re-entered for six years – this does not prohibit people from entering a normal IVA. 

Creditors will not be able to propose modifications to proposals, only answer yes or no. While this in theory simplifies the process (preventing petty haggling of minor conditions), there could be difficulties if there are small but genuniely significant problems within the proposal for a creditor.  

The SIVA would also have no annual report and no court involvement, neither of which would significantly affect the debtor but which would remove burdens for the insolvency practitioner and thus help to make the procedure more cost effective for creditors.

Overall, the SIVA offers a good alternative for those who are struggling with Debt Management Plans but are put off by the complexity and entry criteria of the normal IVA. Negative voting from creditors will be less of a problem, and as long as the no modification clause is implemented effectively, the SIVA could be an important new asset for debtors, creditors, and IPs.

Student Loans not written off in Bankruptcy

While thinking about my blog where I discussed that Bankruptcy is becoming an increasingly attractive option for younger people in serious debt, it struck me that I should have added a Government Health warning for Students.

Student debt is a pressing issue. Students will invariably have to borrow money to get through their studies – paying for tuition fees and reasonable living expenses nowadays seem is largely inevitable. However, As I discussed in my blog of the 16^th August, Students may get themselves into more debt than they need because of the simple fact that they believe that this will be easy to pay off once they get a job.

In my experience, over 70% of debts actually taken out by students while they are studying are taken as loans from the Student Loans Company. This is natural as these loans are relatively easy to obtain. They are attractive because they do not have to be repaid until a certain level of income is reached and rates of interest are generally low.

However, if you are a student and take these loans but you think it will be relatively easy to write them off using an IVA or by declaring bankrupt, think again. Once you have graduated, if you find yourself in serious debt and decide to declare insolvency, your Student Loan debts will not be written off. They stand outside any bankruptcy procedure and will remain payable after such a procedure has been concluded. They will also not be included within an IVA agreement.

My concern is that students are starting to take more and more debt without being concerned about how they are going to pay it back because they are thinking that they can always declare bankruptcy and simply write it off. Beware, this is not the case with Student Loans Company debts!

When talking to people who are struggling with serious debt, I often come across people whose sole income is derived from benefits. Legally speaking, there is no reason why they this type of person should not be allowed to propose an IVA. If after considering a sensible budget, it is clear that they have a sustainable disposable income available, then this could potentially be used as the basis of an IVA proposal.

However, an IVA can only be put in place if the proposal is accepted by creditors. Over the past 18 months, many commercial banks have taken the view that it is not morally correct for someone whose sole income is through benefits to carry out an IVA. The argument is that benefits are means tested and designed to pay for a reasonable cost of living but do not include extra funds for the repayment of debt.

But is this an appropriate approach? The IVA solution is a matter of government policy and an article of English law (the Insolvency Act of 1986). As long as the solution is appropriate and meets the creditor’s financial criteria, it should be the choice of the individual whether they use it regardless of their personal social standing.

The banks take what they say is the moral ground, but it is the banks that have permitted people with benefit income to borrow in the first place – it was not a moral issue at that time. Surely people on benefits should be given the same options as everyone else to resolve their debt problem. After all, if not IVA, then what? A Debt Management Plan will require monthly payments in the same way as an IVA – if the argument is that benefits money must not be used to pay for debt, the Debt Management plan is also taboo.

Given this, we can only assume that those on benefits will be driven by their creditors to declaring bankruptcy, which is surely in no-one’s best interest. My personal view is that IVAs for people whose sole income is benefits should not be dismissed.

The IVA is not a Get Out of Jail Free Card

Reading some of the recent press, you could be forgiven for thinking that the IVA is a slightly underhanded get out of jail free card for people who get into debt. After all, the ads we all see on our TV screens and on the radio suggest that the IVA is a straight forward way of paying off what you can afford over a 5 year period and then simply getting away with any remaining debt being written off. Beware this is definitely the false impression. The IVA is by no means an easy option.

The fundamental which is so often overlooked is that an IVA is NOT a way to wriggle out of paying debt. It is a sensible managed process to pay back as much debt as possible to creditors over a fixed period of time – normally 5 years. As such, the goal is to ensure that creditors are given the best possible opportunity of getting their money back.

To make sure that as much money is paid back as possible, when carrying out an IVA, you will have to live within a very tight living expenses budget which must be agreed by your creditors. This is not going to be a walk in the park and generally you will have to stick to this budget for 5 years. On top of this, if you come into extra money during this period or start to earn more money through promotion or a change in job, you will generally have to pay more to your creditors. On top of a tight budget, if you are a home owner, it is likely that you will have to release equity from your property as part of your IVA settlement.

My intent here is not to be too negative. The IVA is a real solution to resolving a serious debt problem. However, the important message here is that the decision to enter into an IVA must not be taken lightly.  It is most certainly not an easy way of simply getting out of paying debt. However, if you stick to the IVA agreement and manage your budget to ensure your agreed monthly payments are met, you will have light at the end of the tunnel and your debt problem will be a thing of the past.

For the past 12-18 months or so, various groups have grown up to help and support those who feel that they have been charged unfairly by their bank for items such as unauthorised overdraft use. This practise continues to be fuelled each time the banking sector announce  large profits. 

On the one hand, it does seem unfair for a bank to charge around £30 to an individual who is overdrawn by just £5 perhaps only for a single day. Most of us would be extremely unhappy about this and take it up with our bank. However, we would not go to Court over the issue. What we are talking about here is people how consistently and over a long period use unauthorised overdraft facilities thus generating charges of many £100s if not £1000s of pounds.

I can not help thinking that in these circumstances, some of the blame for this situation needs to lay on the shoulders of the individuals who are complaining. Surely if they had better manager their money, they would have realised that they were in danger of stepping over their overdraft limit and acted to do something about this. I have met many thousands of people over the past 10 years who simply never look at their monthly bank statements and really have very little idea of how much money they have in their current account at any one time. Given this, surely the blame for money mismanagement is lies on their shoulders not the banks.   

In July the banking sector announced that they are now challenging the claims of unfair charges in the High Court. As such, future unfair bank charge cases brought by individuals may be suspended until the outcome of the High Court case is known. They outcome of this case will be interesting. Taking personal responsibility for your own actions does not seem to run high on many people’s agenda’s today. However, if the Court rules in favour of the banks, perhaps people will have to start doing just that with their own money.

If you ask the average graduate of 2 years how much debt they have, you should not be surprised if they tell you that this is upwards of £20,000.  The average graduate who has studied for 3 years at university will have taken student loans of c£3000 per year – that’s £9000. They will also have borrowed c£2000 on a credit card and c£2000 on their overdraft. On getting the first job, many graduates will take a loan to get them started – find accommodation, appropriate clothes etc. This could easily be £7000 including interest. Credit card spending does not automatically stop and so over the next 18 mths – 2 years the amount on credit cards may be up to £5000. That’s a total of over £20,000 and a mill-stone around the neck of someone starting their working life. 

When I speak to Students and graduates, I learn that they often take on more debt than they need because they feel that they will be able to repay this easily once they are working. Clearly as a student living on £3000-£4000 a year, it is easy to think that when you get your first job paying £16,000 how could repaying your debt not be a simple?

This is a big mistake. When you graduate and get your first job, this will often mean moving away from home and finding expensive accommodation. If you are bringing home £1000 per month after tax, accommodation costs and bills could easily eat into 50% + of this. Then you have to think about your increased cost of living. You will not be drinking in the Student Union bar with your work colleagues. The cost of socialising for many young people particularly in our cities is extremely high. This all add up to a situation where instead of repaying debt, young graduates find themselves getting deeper into it. The message here may sound boring and sensible to someone still having the time of their life at university. However my recommendation is start to live within your means early. Minimise the debt you take on while a student as much as possible. Once you start work you will be far better off.