deciding what your debt options are

The number of debt solutions can be overwhelming. When there are lots of complicated words and processes that you’ve never heard of, it makes dealing with your debt that much more stressful. In this post, I’ll walk you through the five main debt solutions, so that you can get your head around the ins and outs of them. The next step will be to work out which solution might be right for you.

The five main debt solutions

There are lots of different ways to pay off your debt. Here at MoneyNerd, we often talk about the five main debt solutions. That’s because there are five solutions which are the most successful at helping people pay off their debt, and therefore the most common. This is great news for you, as it means you only need to concentrate on getting your head round these five solutions. Let’s get into them.

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1. Snowball Method

If you can afford to make the minimum payments on your debt, then this method to become debt-free is almost definitely your best option. The Snowball Method is a reduction strategy: you pay off your smallest debt first, while still paying the minimum payment on the larger debts. Then you work your way up, clearing each debt as you go. The great thing about the snowball method is that it actually improves your credit score, whereas the other options will damage it. I go into more detail here about the Snowball Method.

2. Debt Management Plan (DMP)

If you can’t afford to make the minimum payments on your debt, this solution could be for you. With a DMP, you make one monthly payment to your debt management company or charity, and they manage the payments to your creditors for you. It means you keep paying off your debts, but each monthly payment is less than the combined minimum of your debt repayments every month. Furthermore, the lenders often stop charging interest. It’s therefore ideal for a short period if you have, for example, lost your job. Find out more here about what a debt management plan could mean for you.

3. Individual Voluntary Arrangement (IVA)

This solution works well if you owe over £6,000 and need to protect your house from being repossessed. You make monthly payments to an insolvency practitioner (IP). They will then divide the payments between your creditors. These agreements usually last 5 or 6 years, after which all your remaining unsecured debts are written off. I have also written a full guide on IVAs.

Find your best debt solution

debt solution

Is all this information starting to feel overwhelming? Don’t panic! I’ve put together a 4 question debt calculator so you can quickly and easily find the best solution for you. Answer the four questions now.

4. Debt Relief Order

A DRO is suitable if you have debts of less thank £20,000, have barely any income and don’t have a house. You don’t need to pay towards most debts in your DRO, and you can’t be chased by creditors. A DRO generally lasts a year. For more info, read my in-depth article on DROs.

5. Bankruptcy

Bankruptcy is for many people the fastest way to way to hit the reset button. There’s a lot of stigma around the word ‘bankruptcy’, but don’t be put off. It could be the right thing for you to do. Read more here on Bankruptcy.

Comparing debt solutions

Undecided between two solutions? Here I’ve looked at some common options people have to weigh up.

Snowball Method vs Debt Management Plan (DMP)

If you cannot afford the minimum payments on your existing debts, the Snowball Method won’t be an option because this method requires you to make more than the minimum payments each month. If you are in this situation, a debt management plan would be more appropriate.

If willpower isn’t your strongest suit, the Snowball Method might not be the best option for you either. If you are using the Snowball Method, making the extra repayments is voluntary and it can be tempting to spend the money on other things instead. Under a Debt Management Plan you have no choice when it comes to how much you repay because you have to make the repayment amount set out in the agreement each month.

IVA vs Debt Management Plan (DMP)

The key points to consider when deciding between a DMP or an IVA are:

  • Eligibility
  • Duration
  • Interest vs Charges
  • Legal Protection
  • Credit Rating

ELIGIBILITY – Since an IVA is a formal agreement and a DMP isn’t, the criteria for qualifying for an IVA are much more stringent. 

To qualify for an IVA, you need to: 

  • Have unsecured debts that total up to at least £6,000
  • Owe three or more debts to two or more creditors 
  • Live in England, Wales or Northern Ireland 

On the other hand, there are no real criteria to qualify for a DMP. Anyone that has unsecured debt(s) can opt to get a DMP. 

DURATION – DMPs are a good temporary solution, an IVA isn’t. You can stop a DMP whenever you want and resume the normal debt repayments, but they typically last around 10 years. A typical IVA usually lasts five years. DMPs are longer as they require you to pay off the debt in full.

INTEREST & CHARGES – In a DMP, you still have to pay off your interest. In IVA, any interest and additional charges on your debt(s) are immediately frozen. However, IVAs require an initial fee.

LEGAL PROTECTION – An IVA is a legally binding solution. This means your creditors can’t harass you or take legal action (CCJs, petition for bankruptcy, etc.) against you. In a DMP, contact with creditors often lessens or ceases, but it is not a legal obligation.

CREDIT RATING – The impact of an IVA is worse for your credit rating than a DMP. However, it is limited to six years. Credit rating is important, but it is less important than other factors.

IVA vs Bankruptcy

There are three main things to consider when deciding between an IVA or bankruptcy:

  • Your assets
  • Your job
  • The stability of your situation

If you have assets to protect, such as your home or your car, you should opt for an IVA. None of your assets are protected during bankruptcy. You will most likely have to sell everything from your car to your house. 

If you have a professional job that would be affected by bankruptcy, or you have complex assets such as shares in an unlisted company, you should opt for an IVA.

If your personal situation is extremely unstable, for example if you have poor health, irregular income, or a vulnerable job, then you should opt for bankruptcy.

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