The truth about bankruptcy
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Do you know how compound interest affects your debts, and what happens is you get a CCJ? Don’t worry if not, we’ve put together a jargon busting guide to help keep things simple.
When you’re struggling with problem debt, you can come up against terms which make everything seem more difficult. Confusing acronyms and jargon phrases don’t help matters, so we’ve put together a quick guide to some of the common terms around debt that you could be confused by:
Annual Percentage Rate (APR)
The APR on a loan, credit card, or other borrowing is designed to show you the total cost of borrowing over a year, including interest and any extra fees. Store cards can have an APR as high as 29.9% … meaning that if you put £200 on one, you’d owe an extra £59.80 by the end of the year. APRs won’t usually include fees such as late payment charges though.
If you can’t repay unaffordable debts, one solution you could look at is bankruptcy. It’s usually one of the last options after you’ve tried to manage your debts and pay them back, but if they’re building up and spiralling out of your control, you might want to consider a more formal solution.
You’ll have to ask the courts if you can be declared officially bankrupt. Some of your assets will have to be sold to repay what you owe, but you’ll usually be allowed to keep any items which are essential to your job, such as a car, as well as some household items like clothing and bedding. If you are a home-owner you may well have to sell your home. You’ll usually be bankrupt for 12 months and during this time, you’ll be subject to a few restrictions, such as not being able to borrow more than £500 without telling the lender you’re bankrupt. As it’s a formal insolvency solution, it will have a serious effect on your credit score, but this may be better in the long run, as not being able to repay your debts and building up any missed or late payment charges will also affect your credit history.
County Court Judgement (CCJ)
If you have debts that you can’t pay and don’t respond to your lenders when they try to get in touch with you, you could be issued with a CCJ. You’ll be sent a warning letter first, letting you know that your lender is pursing legal action, and you’ll then be sent a CCJ Claim Form. Though this can be daunting and it may be tempting to ignore it and hope it goes away, it’s important that you send it back within 14 days or you could be made to pay the debt in full straight away.
On the CCJ Claim Form, you’ll be able to choose to pay the debt back straight away, pay it in instalments, or launch a dispute against your creditor. CCJs stay on your credit report for six years, so if you get one, you could find it difficult to be accepted for credit in the future. The best way to avoid getting any CCJs on your credit report is to pay off your loans or credit cards on time, but if you’re not able to do this, get in touch with your creditors to let them know you’re having problems.
If you have a loan or credit card with compound interest, it can make it difficult to work out how much you’ll owe once the interest has been added. It means that the interest on your debt is calculated by how much you owe each month, rather than the amount you originally took out … meaning that any interest and charges from the previous month will be added to the total that this month’s interest will be calculated from.
To make it a bit simpler, imagine you still owe that £200 on the 29.9% APR store card. For the first month, your interest will be £4.98, so your new total is £204.98. The 29.9% interest for the second month is then worked out off this new amount, meaning that in the second month, you’ll be charged £5.11 in interest (this doesn’t take into account any payment you might have made or any extra charges). This shows how your debts can quickly start to spiral and become unmanageable.
Debt management plans
If your debts are becoming unmanageable, one option is to enter a debt management plan. This is where you’ll pay off all of your debts but over a longer period. You’ll sign up through a registered company such as the Debt Advisory Centre or a charity and set up a plan, where you’ll have to make an affordable payment every month. This will be worked out based on how much you can afford after your living costs have been deducted, and the payments will be shared out between your creditors. Your lenders may agree to freeze interest and charges on your debts while you’re in the debt management plan so that they won’t be increasing as you’re trying to repay them. However, this might not always be possible.
Debt Relief Order (DRO)
A DRO is a lower cost alternative to bankruptcy for people who are on a lower income and have unsecured debts of less than £15,000. Going bankrupt can actually be quite expensive, as it costs a total of £705, while a DRO only costs £90. To qualify, you’ll have to have a monthly disposable income of less than £50 after your essential living costs have been deducted, as well as assets of less than £1,000, including a car worth up to £300.
Defaulting on a loan or credit card debt means that you haven’t paid what you owe or have agreed to pay. Your lender or creditor will send you a formal letter, called a default notice, after you’ve missed a few payments telling you how much you need to pay and giving you 14 days to do so. If you don’t pay, they may apply for a CCJ, pass your debts to a debt collection agency, or take back goods if you’ve bought them on credit. Don’t panic if you receive one of these default notices … we’ve put together a guide for dealing with late or missed payment letters.
Individual Voluntary Arrangement (IVA)
An IVA is another type of formal debt solution, so it will also have a serious effect on your credit score. You’ll pay as much as you can afford towards your unsecured debts for a set time, usually five years, but it can be longer. After this time, any remaining debts will be written off. For more information on whether an IVA is right for your situation, click here.
When you have a credit card, there will be a minimum repayment you have to make each month to avoid defaulting on the balance. This is usually a percentage of how much you owe (subject to a fixed minimum), so as you start to pay money back, your minimum monthly repayments will get smaller too. This means that it could take you a very long time to pay back all of the money you owe. It’s always best to pay as much as you can afford each month, as not only will your debt be cleared quicker, but you’ll also build up less interest, so you’ll pay less in total.
Check out our guide for more information about how you could be missing out if you only make the minimum repayments each month.
Priority and non-priority debts
Managing several debts at once can be hard, and it’s sometimes difficult to know which one you should try to repay first. It can be helpful to divide up your debts (and bills) into those which are priority and non-priority as this usually gives a basic guide over what needs to be tackled sooner. Priority debts have more serious implications if you don’t pay them … losing your home, going to prison, or having your heating switched off. They include your mortgage or rent payments, secured loans, council tax, utility bills, food and other living costs.
You still need to repay your non-priority debts, of course, but it’s less serious if you have problems with them. Non-priority debts include payday loans, credit cards and store cards, unsecured personal loans and overdrafts. If you speak to a debt advice expert about formal debt solutions, you may be able to work out a repayment plan for your non-priority debts after you’ve repaid your priority debts. For advice on what debts count as priority and what count as non-priority, have a look at our guide.
by Emily BancroftBack to blog home