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This is a guest post from Sara Williams, a Citizens Advice adviser who blogs about debt and credit ratings at Debt Camel.
If you are getting deeper into debt every month then at some point that has to stop! Catch it early enough and you can do what Katykicker did: pay it off by earning more and spending less. That way you end up with a great credit record and great money habits.
But for some people that isn’t possible because their debts are too large. Here is an overview of the two most common debt solutions, DMPs and IVAs.
Debt management – the most popular choice
Debt management is sometimes called a DMP (debt management plan) – debt advisors love things with initials!
In a DMP your creditors are asked to freeze interest. Most of them do! There are hundreds of thousands of people who have these sorts of arrangements with their banks, credit cards and catalogues.
This can work well. Paying the minimum to credit cards and the balance never seems to drop. But freeze the interest and it starts falling.
You will get arrears and then defaults added to your credit record but there isn’t a way round that. If you can’t pay your debts, your credit record is going to suffer.
DMPs are flexible so if your expenses go up you can pay less. This makes them a good choice if you expect things to improve later, perhaps when your childcare costs drop.
Work out how long a DMP will take. If you can pay £120 a month to your debts and you owe £6500, it will take 6500/120 = 54 months, so four and a half years. If that seems too long, think about more drastic options – one of the types of insolvency such as an IVA.
To find out more about how to set up a DMP – you can do it yourself but if you have lots of debts it’s easier to get a firm to do it for you – read my Guide to DMPs.
IVAs – a 5 or 6 year contract
An IVA (individual voluntary arrangement) is an alternative to debt management that is less well known. They can vary a lot but this is typical:
- you make monthly payments for 5 years;
- in the last year if you have a house you try to remortgage so you can pay in more money to your IVA. If this isn’t possible, your IVA is extended for a sixth year;
- at the end of the IVA, your debts are written off.
Sounds good, having your debts written off at the end! That is the major advantage of IVAs. The other plus is that for many people an IVA should be over quicker than a DMP.
But also look at the downsides. Firms make big fees from managing an IVA. Sometimes they are, shall we say, a bit keener to describe their good points than their bad ones…
An IVA is a type of insolvency, like bankruptcy. It’s on your credit record for at least six years. During that time you won’t be able to get a mortgage and it’s difficult to rent as you will fail a credit check. If your PCP car term ends during your IVA, you won’t be able to get another one.
Even after the IVA, some mortgage lenders will refuse to lend to you. They treat it the same as having gone bankrupt.
If you earn more, half has to go to your IVA. If you inherit any money that all has to go to your IVA.
An IVA is a formal legal contract. Probably dozens of pages long! There is a little flexibility – you may be able to take a payment break and have the months added on at the end – but not all problems can be sorted.
About a quarter of IVAs fail when people can’t afford the monthly payments. Then they are left with all their original debts plus the IVAs fees and a wrecked credit record… that’s a disaster.
For more information about IVAs, how they work and what happens when you are in one, see my Guide to IVAs.
So how should you decide?
I suggest sit down with your partner, or a friend if you are single, and brainstorm what could change in the next few years in your lives.
If your job is stable, you aren’t likely to have another baby or want to move house, then you may feel confident enough to make the 5 year commitment to an IVA and benefit from the debt write-off at the end. If things feel pretty uncertain, the more flexible DMP is probably better.
Also look at your other options. If you are renting, bankruptcy could be a much better option than an IVA – over much quicker, seven out of eight people don’t have to make any payments at all and it can’t fail!
If you would like some expert help to choose, talk to your local Citizens Advice. They won’t make any money from you whatever you go for, so you know it’s unbiased advice.
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