How to Manage Debt – All You Need to Know, FAQs & More
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Without proper attention and planning, debts can definitely spiral out of control.
This is why it’s important to have a plan on how you intend to take care of your debts so you can pay them off within a reasonable time.
In this post, I’ll be looking at some ways to manage debt, talking about how you should be prioritising different types of debts and what options you have if you’re struggling with debt.
Getting Free Debt Advice
When you’re struggling with debt, it can be a good idea to seek out the help of a professional. Debt advisors are individuals with extensive knowledge of how debts work and they can help you carve out a path to financial freedom.
Debt advisors are typically empathetic individuals who will never judge you or make you feel embarrassed about the situation that you’re in. They will suggest effective ways for you to deal with your creditors (in some cases, they may even negotiate with creditors for you). Furthermore, they might be able to suggest ways of dealing with your creditors and debt which you may not be aware of.
That being said, it’s extremely important that you don’t seek advice from an agency that charges you money for it. Of course, it would be an extremely bad idea to pay for debt advice when you’re already drowning in debt.
That’s why I highly recommend that you seek advice from any independent debt charities that are currently operating in the UK.
When you’re dealing with multiple creditors and many different types of debt, prioritising them can get quite confusing.
Some people try to treat all of their creditors equally and distribute payments between them but this is definitely not the way to go.
Truth is that you need to set up a priority list which details which debts are attended to first and which ones can be left till later.
This may seem obvious but you should always take care of debts that have more dire consequences for you if you miss their scheduled payments. These types of debts are known as priority debts.
Some examples of priority debts include:
- Mortgage payments
- Rent arrears
- Council tax bills
- Tax credit overpayments
- Child maintenance bills
- Income Tax, National Insurance and VAT
- Utility bills
These are all examples of debts that should always be attended to first before you deal with any other payment to other creditors.
Once all of your priority debts are dealt with, you can start looking towards non-priority (or unsecured) debts.
Prioritising debts among unsecured debts can be more tricky but you should always look at your creditors in order to determine who to prioritise first. Of course, if you have a bigger debt to a certain creditor and a shorter repayment duration for it, you should always prioritise that creditor first.
Make sure to keep your payment deadlines in mind when prioritising different creditors.
Some examples of unsecured debts include:
- Credit card debt
- Catalogue debt
- Personal loans
- Banks or building society loans
- Cash borrowed from friends or family
Interest rates can also play a factor in how you prioritise different types of unsecured debt.
If a certain debt has a higher interest rate, you should try to repay it as soon as possible. Thus, you should give it higher priority. This is because the longer you keep making your repayments towards a debt with a high interest rate, the more additional money you’ll have to repay.
Options for Dealing with Debt
There are a number of debt solutions that you can take advantage of if you’re having trouble paying back your debt.
That being said, not every debt solution is appropriate for every financial situation which is why it’s important that you do your research and seek advice from a professional before opting for any one solution.
Most debt solutions give you legal protection from your creditors and you might be able to write off all of (or a portion of) your debt.
That being said, almost all such debt solutions get recorded in your credit report. They stay in your credit report for six years. In the future, whenever you’re seeking credit, lenders will be able to see in your credit report that you opted for a debt solution within the past six years. This will make them apprehensive about offering credit to you.
Some examples of debt solutions you can opt for are:
Individual Voluntary Arrangement (IVA)
An IVA is a formal debt solution between you and your creditors which allows you to pay off your debt in monthly instalments for an agreed-upon period of time. This period is typically five years.
Once this period is over, any remaining debt that you have is written off.
Furthermore, an IVA protects all of your assets from being seized and sold off.
The amount of money you pay in your monthly payment plan is based on how much you can afford.
It’s important for you to know that if you’re a homeowner, you will be required to release equity from your home in the last year of your IVA.
If you’re not a homeowner or don’t have equity in your home, then your IVA will be extended by one year. This would mean that if you don’t own a home, then instead of five years, your IVA would last six years.
Bankruptcy allows you to write off all debt you have. That being said, bankruptcy has an incredibly negative impact on your credit score.
While bankruptcy allows you to write off all your debts, it does not protect any of your assets.
They will be seized and sold off as part of the process. This is why bankruptcy is definitely something you should avoid if you have valuable assets that you want to protect.
Debt Relief Order
A debt relief order is a cheaper alternative to bankruptcy. It is aimed at individuals that earn very little money and have little to no assets to their name.
The eligibility criteria for a debt relief order is quite strict so not many people qualify for it.
A DRO involves you freezing your repayments towards your debt for a 12-month period.
At the end of this 12-month period, your financial circumstances are re-assessed. If they’ve gotten better, you will be required to pay off your debt. If they have not, then all of your debts will be written off as part of the debt relief order.
A debt relief order can allow you to wipe off your debt in a short amount of time but it can definitely cause problems in the long-term such as difficulties acquiring credit in the future.
Debt Management Plan (DMP)
A DMP is an informal debt solution that you can negotiate with your creditor(s).
A DMP being an informal solution means that it does not protect you from your creditor(s) in the same way that an IVA would. This means that your creditor(s) can still take legal action against you even if your DMP has been accepted and put in place.
The great thing about debt management plans is that they’re extremely flexible and you can customise your repayment plan in case your financial circumstances change.
Additionally, you can utilise them if you have debt that is too little to be accommodated by an IVA or other formal debt solutions.
Full or Final Settlement Offer
A ‘full or final’ settlement offer involves you paying a single lump-sum amount to your creditors in order to settle your debt.
You could go with this debt solution if you have a large lump-sum amount that you can provide to your creditor(s) but you don’t have a steady stream of income which would be more appropriate for other types of debt solutions.
The lump-sum amount can be lower than the actual amount of money you owe. Your creditor(s) will be more accepting of your offer if they feel that you’re not going to be able to pay back the debt within a reasonable time.
You can choose to negotiate with your creditor(s) on your own or you can also look towards debt settlement companies that could do this for you.
There’s a chance that you may be able to apply to County Court for an Administration Order if you:
- owe less than £5,000 in total
- Are earning enough money to make regular payments towards your debts
- have at least two debts – one of which must be a County Court Judgment (CCJ) or Higher Court Judgment against you.
An administration order would involve you making monthly payments from your income (straight from your bank account) to the court for the full amount of money you owe.
The court would then distribute the amount among the people you owe it to.
Debt Solutions and Credit Scores
While debt solutions can definitely help you take care of your debts, they can hinder your ability to obtain credit in the future.
This is because when you opt for any debt solution, it gets recorded in your credit file. A record of the debt solution stays in your credit file for six years after the date on which it was registered.
As you can probably imagine, this has a significantly negative impact on your credit score and as a result of this, you may not be able to secure credit or loans from traditional lenders.
Even if you’re able to secure a loan from a lender, you will most probably get it at an extremely high interest rate or you may not be able to get a loan amount as high as you wanted.
Managing debt can be quite overwhelming but if you take it step-by-step and seek the proper advice, you can easily become debt-free within a reasonable time.
Just be sure to assess your circumstances thoroughly so you make the appropriate decision for yourself.