When you take on debt, you make a commitment. As long as you can fulfil that commitment, everyone is happy. If, however, you start to struggle to make that commitment, then neither you nor the lender are happy. Fortunately, there are many ways to resolve these situations and it’s in the lender’s best interest to cooperate with them.
Understanding your debt situation
Dealing with problem debt is a lot like planning a journey. You take your starting point and your ending point and then work out the best route between them. In the case of problem debt, everyone already knows their ending point. They want to become debt free. What people may not know is exactly where their starting point is.
This means that your first action needs to be to ensure that you really do have a clear picture of all your debts. Specifically, you need to know what is owed to whom and under what conditions. You also need to have at least a reasonable idea of your future income and assets. The more accurate you can be about these, the better you will be able to judge your options.
Are you solvent or insolvent?
If you are solvent, you are able to make at least the minimum payment on your debts while still maintaining a basic standard of living. If you are insolvent you are not. While this is simple in theory, modern working practices can make it a bit more complicated to work out in practice.
For example, a person with a highly seasonal working pattern may be solvent for part of the year but insolvent for the other part. They would therefore need to look at their income and liabilities over the whole year to see whether or not they were solvent.
Do you need a break to assess your situation in peace?
The Debt Respite Scheme, also known as the Breathing Space Scheme, was introduced in 2021. As its name suggests, it’s a scheme that gives debtors breathing space from their creditors for up to 60 days. Debtors should use this time to work with a professional debt counsellor to find a longer-term solution.
For clarity, the end result of a Debt Respite scheme may be that the borrower declares insolvency. This is, however, not necessarily the case.
If you are solvent
If you are solvent, you can choose between two main strategies for clearing your debts. With both methods, it’s vital to continue to make the minimum payment on all of your debts.
In the snowball method, you put all your disposable income towards clearing the smallest debt. In the avalanche method, you put all your disposable income towards clearing the most expensive debt.
You may wish to run the sums to see which method would be more cost-effective for you. If, however, you have a strong inclination for one of these methods, you should probably just go with whatever you find easiest.
If you are insolvent
Counterintuitive as this may seem, if you are insolvent, you may not have to declare any form of insolvency. Instead, you and/or your debt counsellor may work with your creditors to reduce your debt burden to bring you back to solvency. There are three main reasons why this approach can often be successful.
Firstly, creditors are legally obliged to do whatever they reasonably can to help people in financial difficulties. Secondly, getting a reputation for being unhelpful to people in difficulty can seriously hurt their brand image. Thirdly, they are likely to end up with at least as good a deal as they would get if you went insolvent. They may even get a better one.
If, however, you do need to declare insolvency, then you do not have to go straight to bankruptcy. Depending on the level of your debts and your assets, you may find that a Debt Recovery Order (DRO) or an Individual Voluntary Arrangement (IVA) may be a more suitable option.
