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In an ideal world, as soon as a borrower realises that they are in financial difficulty, they should reach out to their lender to work something out with them.  In the real world, however, it is more than possible that it will be the lender who realises that something is amiss and reaches out to the borrower.  In either case, the ideal scenario is that both parties act in good faith and negotiate to find a reasonable settlement.  The key word here, is reasonable, lenders are simply interested in recouping as much of their money as possible and they can’t get what you don’t have, but they can get a charge put on assets you would prefer to keep.

There is no such thing as “unsecured” debt if you have assets

In the UK, for practical purposes, the only people who have genuinely unsecured debt are people who have no assets at all.  If a borrower does possess assets then a creditor can go through a legal process to have “unsecured” debt converted into secured debt.  Borrowers are recommended to keep this in mind when deciding what action to take on their debts.

The law will usually expect you to sell your assets fairly to pay your creditors

If you have any ideas about disposing of your assets before applying for bankruptcy, then be aware that both lenders and the law caught onto this strategy a long time ago and that therefore you should proceed with extreme caution, if at all.  For example, if you own a property jointly with your spouse, but the debts are in your name alone, then it may be possible for your spouse to buy your share of the equity at a fair market value.  It is, however, highly unlikely for it to be possible for you simply to gift your share of the property’s equity to your spouse or even to sell it at below market value.

When assets aren’t enough

If you have sold your assets (or never had any) and still cannot reduce your debts to a manageable level, then you have two options, one is to go down the route of insolvency and the other is to persuade your creditors to settle for less than they are owed, but more than they could reasonably expect to receive in an insolvency situation.  This latter option depends on being able to access funds from another source (typically family or friends), which would be out of bounds to lenders if you went insolvent.  In order to minimise the burden on their loved ones (and themselves if the money has to be paid back eventually), borrower’s will generally want to offer the lowest amount the lender is likely to accept.  How much this will be in real terms will depend on the lender’s view of the borrower’s circumstances.

Is a borrower’s situation likely to improve?

This is basically the question creditors will want to answer.  In simple terms, the more likely a lender thinks it is that a borrower’s situation will improve, the more likely they are to hold out for a higher settlement offer now and, by contrast, the more likely a creditor thinks it is that a borrower’s situation will deteriorate (from a financial perspective at least), the more likely it is that they will settle for a lowball offer.  Another way of looking at this situation is that the more a lender thinks a borrower will want to avoid bankruptcy, the more likely they are to resist lower offers and vice versa.

Once an offer has been agreed

Once you have agreed an offer with your creditors, make sure that the settlement documentation is worded in such a way that acceptance of the offer is legally binding on them.  Once you have made good on your offer, your credit balance should be set to zero and a “partial-settlement” marker will probably be placed on your account and credit record.  This is different to a default.

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