Big budget month day 27: clear your debts

If your debts are spiralling and you don't know how you're going to deal with them, you have four practical options.

'Robbing Peter to pay Paul', 'a slippery slope', 'the debt spiral'...Debts are bad enough as it is without having to contend with clichéd expressions. I can't stand them. So, without cliché, in plain English and without further ado, here are the five ways to deal with your debts.*

1. Better money management

You need to work out where your money is disappearing and put an end to it. There are some simple ways to go about this.

Keep a diary for one month of every single little purchase and withdrawal you make. This is a good way to see where money is disappearing to; the result is often surprising.
Write and stick to a monthly budget. You should consider all your areas of expenditure. To that end, people with hefty debts should look at and use our free and secure MoneyTrack tool.
Use what you've learned from your spending diary, budget and statement of affairs to look for ways to make cutbacks and start living below your means.
Use the excellent technique of snowballing, or consolidate your debts (but beware the risks of consolidation. Read Should I Get A Consolidation Loan?)

Pros
If you can start managing your finances better and living within your means, this is the ideal way to get out of debt.

Cons
You might simply be unable to make the tough decisions required to focus on your finances and cut back on spending. Or, no matter how you try, you might find it's impossible.

2. Debt management plan

You can write to your creditors and appeal to them to lower your minimum monthly payments and to freeze interest. If they agree, the deal won't be legally binding, so they can retract the agreement at any time. The plan is likely to be reviewed every six months too. At best this gives you breathing space, but this might be all you need to get your finances in order.

Citizens Advice and debt charity the Consumer Credit Counselling Service (CCCS) can help you to write a debt management plan for free.

Pros

It's better to come to some sort of temporary arrangement with your creditors rather than missing payments.
It cuts out the need to borrow from elsewhere just to meet existing debt payments.

Cons

Your credit rating is still affected, and default notices might still be issued.
Not all creditors may agree to freeze interest, which means you end up paying far more in the long run.
You extend the time you spend in debt even further.
You might find yourself constantly worrying about when or whether your creditors will change their minds.

3. Individual Voluntary Arrangement (IVA)

Unlike a debt management plan, an IVA is a legal contract that might last, say, five years. You can have lower monthly payments and write off a portion of your debt. Any reductions in payments or in the total bill you owe your creditors is fixed, once they agree -- if they agree.

IVAs are not the universal cure that they are made out to be. They are unsuitable for a large number of people. The charges for IVAs can be very high. I suggest you think carefully before taking debt advice from a company that sells IVAs, as it's likely they make all or most of their money from them.

The good news is that the Consumer Credit Counselling Service offers IVAs. It offers lower prices, higher transparency, and only offer IVAs when it's the best solution for you.

Pros

Your creditors write off some of the debt.
Interest and charges are frozen.
You might well be able to keep your house.
You don't face the stigma of becoming bankrupt, and you can keep your job if you're in a profession where you're not allowed to be bankrupt.

Cons

You can be locked in to making IVA payments for five years.
After a year, you may have to remortgage in order to keep your house and pay off some of your debts.
You can't get significant unsecured credit.
Your credit rating is affected for six years, which means new mortgages will cost more and you might have to put down a larger deposit.

4. Bankruptcy

Contrary to popular belief, bankruptcy is often a better option than an IVA. Personally -- although I know that many people strongly disagree -- I don't think that people should feel bad about bankruptcy, as irresponsible lending and Government policy has encouraged people to take on more and more debt. What's more, financial education is non-existent.

Bankruptcy (especially the softer bankruptcy regime that has been introduced in recent years) is necessary if people are being deliberately driven into serious debt in order to increase company profits and to give a false and temporary boost to the economy.

Pros

Most of your debts are cleared.
You're discharged from bankruptcy within about 12 months.
You get to keep reasonable assets -- household items such as your fridge, settee and DVD player -- provided they are not exceptionally valuable.
Payments to the court can last a very short period, and usually no more than three years, which is two years less than a typical IVA.

Cons

You will probably lose your home.
You lose a lot of your assets, including cars worth more than £1,500.
Your name is published in your local paper and the London Gazette.
Any extra money you get must be paid to the court, perhaps for three years.
Your credit rating is badly damaged for six years.
While you're bankrupt you aren't allowed to be employed in some professions.

There is also a cheaper and more simple form of bankruptcy if you have few assets called a debt relief order.

5. Panic!...Or...

The fifth option is a wholly unnecessary one: to panic. If you feel like panicking, visit the Dealing with Debt discussion board. There you will get support and guidance from other debtors, former debtors, experts and other helpful folks who'll advise you on all four of the options above. What's more it's anonymous. I think that this discussion board should be the first point of call for anyone with serious debts. You won't regret it!

Pros (of panicking)

Gives you something to complain about other than the weather.
It builds character.
It comes with a free button (a panic button) and a free station (a panic station).

Cons

It's not productive.
It's unnecessary. There is always a solution to your money woes.

For this article, I consulted heavily the excellent book IVA, Bankruptcy and other Debt Solutions, by James Falla. I recommend this book to anyone who has serious debts.

*Just don't wait till the chickens come home to roost before doing something about them.#

This is a classic lovemoney article that has been updated