Legal changes have tried to remove some of the stigma of bankruptcy - and those that go down this route are discharged after just a year. But they will still feel the repercussions for many year afterwards. Even once discharged a bankruptcy record will stay on your credit file for at least five years - making it difficult to obtain a mobile phone contract, let alone a bank account or mortgage.
An IVA may seem like a less severe option - but even this too will affect your future credit rating. In some cases people may find it difficult to rent a flat or even get a particular job, if it is a financially sensitive position.
If your debts are threatening to get out of control you should as a priority seek debt management advice. There are a number of reputable debt advice agencies who should explain the options open to you, without trying to sell you a particular "debt solution".
Among other things, debt advisers will help you prioritise repayments, to ensure there is less chance that your home is repossessed.
Bankruptcy and IVAs should be seen as a last resort, and in many cases may not be necessary. Debt Free Direct says one third of its customers enter debt repayment plans, which are informal arrangements with creditors.
The key is to get individual advice. If you have no assets and no income then bankruptcy is probably the best option. But if you are in a professional career you may lose your livelihood by going bankrupt - solicitors and accountants, for instance, will be kicked out. So an IVA may be a better option.
The following provides more information on each course of action.
Individual Voluntary Arrangements (IVAs)
IVAs were introduced to provide an alternative to bankruptcy. The types of debts dealt with by IVAs can include personal loans, credit card balances and other forms of "buy now, pay later" unsecured loans.
An IVA is a legally binding contract between a debtor and his or her creditors. It allows a person to make a formal proposal to settle a debt within a reasonable and fixed period of time. The contract is typically for five years.
An insolvency practitioner (IP) will help put the proposal to creditors and negotiate an agreement. The debtor will have to disclose full details of his or her financial circumstances.
If more than 75 per cent of the creditors accept the terms of the proposal, it is binding on all the creditors. Creditors can put forward changes to the proposal but the debtor can decide whether or not to accept them. Any interest and debt charges will be frozen and creditors are not allowed to demand additional payments.
The debtor will make monthly payments, usually a minimum of £200, to the IP based on what it is agreed the debtor can afford. Once the final payment is made, any remaining debt is legally written off.
Bankruptcy
A bankruptcy order may be obtained by any creditor owed more than £750. A debtor can bankrupt himself by filling in the relevant forms at the County Courts.
The debtor's assets are then sold and the money is distributed - after the insolvency practioner's costs - to creditors. Some assets, unless they are of very high value, are exempt. These include tools of trade, pensions, ordinary household contents and possessions - including a car. In most cases, bankruptcy ends after one year or less. After this, the slate is wiped clean.
IVAs versus bankruptcy
Credit-rating agencies do not make much distinction between an IVA and a bankruptcy case.
One of the biggest set backs with bankruptcy is that you may lose your assets - including your house - but the IVA process is different. You may have to give up some of the equity in your house, but you will not necessarily lose the roof over your head.
Bankruptcy is also public matter - legally, there are some people that must be informed, such as your bank. It will also be published in newspapers, so you will not be able to control who finds out. An IVA is a more private option. While your IVA will be published on the Insolvency Service Website, it will not be published in any newspapers.
But going bankrupt can take the pressure of creditors away from you. You are allowed to keep certain things, like household goods and a reasonable amount to live on. When the bankruptcy order is over, you can make a fresh start and the money you owe is usually written off. In many cases, this can be after only one year.
The downside is that even when you are no longer bankrupt, you could have another order (called a "bankruptcy restrictions order") made against you. These orders can be made if, for example, you took on debts knowing that you had no hope of paying them back. A bankruptcy restrictions order can last for 15 years and will make your financial affairs very restricted - even when you are no longer bankrupt, there are some debts such as court fines and student loans that will never be written off.
Remember that the set up costs of an IVA can be high and you may have to pay an upfront fee. You can also only take out an IVA if you can afford to repay some of your creditors - and if you don't keep to the payments, you can be made bankrupt anyway.
