The broad definition of insolvency is the inability to pay debts as they fall due. While almost everyone is short of funds at various times in their life, true insolvency is a circumstance where you find yourself in long term financial difficulties, with no apparent way out of the situation.
If you can never make more than the minimum payments on credit cards, or if direct debits are returned unpaid on a regular basis, you are insolvent in the true sense of the word. If you have no realistic expectation of repaying your debts, insolvency may be your best alternative, although it is not a suitable strategy for everyone.
The two main forms of formal insolvency are bankruptcy and Individual Voluntary Agreements (IVAs). Neither option should be seen as an easy way of escaping your debts, and neither should be entered into lightly. These are some of the circumstances where insolvency may be the best option.
No assets and low or no income
If you have no valuable assets and are on the minimum wage or have no income to speak of, bankruptcy may be your best option. Any one of your creditors can force you into bankruptcy if you owe them more than 750GBP, or you can file for voluntary bankruptcy in your local County Court.
Your assets will be sold and the proceeds paid to your creditors in order of their importance. Tools of the trade, essential household possessions and pensions are exempt from the bankruptcy procedure, so you will not lose the the bed you sleep in, the means to carry out your employment or any provisions you may have made for retirement.
After a year, the bankruptcy is discharged and the remaining debts are wiped out, although some bankrupts may be under restrictions for up to 15 years. This usually happens only in cases of irresponsibility or deception – for example if, before bankruptcy, you borrowed money knowing you would be unable to repay it.
Professional people such as solicitors and accountants will lose their livelihoods if they are declared bankrupt, and even when the bankruptcy is discharged, there may be further difficulties. For example, discharged bankrupts may have problems getting a mobile phone contract or a mortgage.
You want to protect your assets and your career
Bearing in mind that creditors can force you into bankruptcy, it may be sensible to protect what you own by entering into an IVA. 75% of your creditors must agree to this, and you will be committed to a schedule of payments for a period of five years. An IVA is not public like bankruptcy, so it may be a better option for professional people whose careers or businesses may suffer if the state of their finances became known.
IVAs are only available to those who can afford to pay off some of their debts, and the set up costs can be high. These will usually be recovered from your repayments, and after five years, the rest of the debts are usually written off. However, if you fail to maintain the repayment schedule, you could still be made bankrupt.
The stress is becoming too much
Once a formal insolvency agreement is made, creditors are not allowed to pursue you for outstanding debts, and interest is frozen. If the stress of receivind final demands and indignant phone calls is making you ill, a formal insolvency will ease the pressure. You may find it easier to sleep at night once there is a plan of action in place to tackle your debts.
Your credit score isn’t important to you
Both bankruptcy and IVAs can impact on your credit score for around five years – possibly longer. If you’re not likely to seek credit in the future – say for a mortgage, car loan or big ticket purchase – insolvency will help you to deal with your existing debt and prevent you from incurring further financial obligations.
Before deciding that insolvency is the best course for you, take specialised advice on your individual circumstances. You do not have to pay for this – the Consumer Credit Counselling Service offers confidential, free advice in the UK, and there are similar bodies in other countries.