If you're in debt and facing the possibility your home may be repossessed, watch out for the IVA vultures who will try to scam you out of £13,000.
Britain's personal debt is increasing by £1 million every five minutes, according debt charity Credit Action. And the situation only looks set to get worse following the credit crunch, with the Royal Institution Of Chartered Surveyors predicting there will be 123 repossessions every day this year - an increase of 50%.
With energy bills, mortgage rates and the pace of personal inflation increasing dramatically over the past year, it's not surprising that many households will struggle to make ends meet.
What scares me is the extreme lengths that homeowners are increasingly being persuaded to go to, in order to ensure they do not lose their home to their creditors. That's why, in A Dangerous Way To Get Out Of Debt, I looked at the terrible risks of 'sell and rent back' schemes.
Today I want to look in more detail at another potentially problematic way of dealing with debt: Individual Voluntary Arrangements (IVAs).
An Easy Way Out Of Debt?
IVAs are often sold to borrowers as an easy way to `write off' what they owe: you are told that the IVA process is free, the interest on your debt will be frozen, and you only have to pay back whatever is affordable every month. What's more, you will only have to pay back a proportion of your outstanding debt.
Then after just 60 months (usually), your debt will be cleared, and a successfully-completed IVA should look OK on your credit record.
This can seem like a dream solution, especially for homeowners who are facing repossession.
But if you're sensing there's a nasty catch hidden somewhere, you'd be right on the money. The alarm bells should have started ringing the moment you read: "you pay back whatever is affordable every month".
In reality, you may find you and your creditors have very different views about what is an `affordable' monthly payment. Usually, they will expect you to pay back 100% of your disposable income. In plain English, that's everything you earn, after you've paid your mortgage, council tax, bills and bought essentials like food. You're usually only allowed £50 a month for emergencies, such as your car breaking down, boiler blowing up, etc. And you'll usually have to keep that up for five years. Sounds a lot longer than "60 months", doesn't it?
What's more, in the fourth year, you will be expected to increase the size of the mortgage on your home to 85% of the property value and give the money you receive from the mortgage lender to your creditors.
This means that, even after you have successfully completed your IVA, you could find you have very little disposable income every month, as the size of your monthly mortgage payments may have increased substantially. And this situation will last as long as your mortgage term (so, in some cases, for 25 years or even longer).
Are IVAs Ever A Good Idea?
Despite their hidden flaws, there is no doubt that IVAs can be a good solution for many people in debt. This is because if you opt for bankruptcy instead, your home and other valuable assets (such as your car) are likely be repossessed.*
What's more, you will have to declare that you are a bankrupt when applying for a mortgage or any other form of credit, which means that you will often get turned down. Also, you cannot work as a lawyer or a banker, or any business regulated by the Financial Services Authority.
None of this happens with an IVA so it's easy to see why it can be an attractive alternative (especially if you're a lawyer!).
Bankruptcy Can Be Better
On the other hand, for some debtors, bankruptcy can be a much better option than an IVA.
This is because, once you've handed over your assets, you should find you are better off financially as a bankrupt. While you will still often have to make monthly payments to your creditors from your income, this should be at a more affordable level than the IVA payments: typically between 50% and 70% of your disposable income. And you only make these payments for a maximum of three years, not five.
That's it. After that, you can start afresh, without any heavy monthly repayments weighing you down.
A Last Resort
Despite this, most homeowners see bankruptcy as the absolute last resort, in case they lose their home. So, when they are told they can afford an IVA, they immediately sign on the dotted line.
The problem is, if you opt for an IVA, and then don't keep your side of the bargain - if you consecutively fail to meet three of the so-called 'affordable' monthly payments - then your creditors may petition the courts to declare you bankrupt. And that means all the hard work and money you put into paying the IVA over the months or years will have achieved you very little: you'd still potentially lose all your assets, including your home, and suffer the stigma of bankruptcy.
That's why it's vital that only debtors who can truly afford to keep up with their monthly repayments opt for an IVA.
And unfortunately, there is a great incentive for companies to mis-sell IVAs to debtors who would be better off opting for bankruptcy.
The average Insolvency Practitioner - whose job it is to get the debtor's creditors to agree to an IVA, and then manage it throughout the five years - typically charges the creditors a fee of £8,000 to £9,000. (What's more, some Fools on our Dealing with Debt discussion boards say they have seen fees of up to £13,000!). This fee is, of course, added to the `interest-free' debt that the debtor must clear.
The Good News - And The Bad
Happily, I do have some good news to impart to you. The Insolvency Service, a government body, has finally created an IVA protocol, which members of the British Banking Association have agreed to abide by. These standards seek to protect IVA customers from poor advice and misleading information.
But sadly, I also have some bad news. The protocol is a voluntary code and therefore unenforceable. Personally, I am sceptical about whether it will actually manage to flush out bad practice. If companies can make more money by disobeying the code, call me cynical but I suspect some will continue to do so.
There are, no doubt, many good insolvency practitioners and debt management companies out there who more than earn their fees (I was particularly impressed by The Bankruptcy Advisory Service, for example, as well as the advice given by several kind Fools on our Dealing With Debt discussion board).
But there are also enough cowboys keen to make a fast buck to ensure that, unless action is taken to clean up this industry, mis-selling will continue to flourish - and debtors will continue to suffer.
*For more info on the pros and cons of bankruptcy, IVAs and debt management plans, read Five Top Ways To Clear Your Debt.
More: The Dealing With Debt Discussion Boards | IVAs And Bankruptcy |A Dangerous Way To Get Out Of Debt