The top three ways to deal with debt

Neil Faulkner reveals the top three ways to tackle debt.

The past month has revealed some dreadful numbers with ever more people going bust. Already 99,000 have declared themselves insolvent this year,* with another 30,000 likely to be on the way. That would be a 20% increase on last year's figures.

If you feel you're close to adding to those statistics, let me tell you how you can deal with your looming problem. I've categorised all our debt solutions into three broad categories:

1. Money management

Your first steps to consider are budgeting, reducing outgoings and increasing income. Start by writing a proper budget (here's how to to do it). Bargain-hunting should become part of your routine. Look at our Ways to save Q&As for ideas and think creatively about how you can cut each aspect of your budget from entertainment, presents and holidays to transport, utilities and TV. Don't think about cutting back on your priority debts though. As for increasing income, consider getting a second job or renting a room.

Snowballing is a wonderful technique for reducing your debts faster. Forget about paying off your smallest debts first; you should concentrate instead on your debts with the highest interest rates. You'll end up paying a lot less interest and be out of debt much much faster. Read more in this article.

Consolidation loans. Consolidating debts into a single unsecured loan or credit card can reduce your repayments, but it is not a buy-and-forget solution. The debt is still there, and just as large.

You can't consolidate without budgeting first. A few surveys over the past ten years have shown that most people who consolidate fail to get a grip on their finances and end up increasing their debts! Hence, consolidation is a solution that only works if you do it in conjunction with better money management. You can get hints and tips from other lovemoney.com readers using our Q&A tool.

One more thing: secured loans are often sold as consolidation loans, but you should take advice from National Debtline, the CCCS or Debtline NI before taking out this type of loan.

2. Informal insolvency procedures

It's always best to be up front with your creditors if you can't pay your bills, but if you envisage that  your circumstances will improve in, say, six months, you could be up front about that too.

By writing a debt management plan, you can negotiate with your creditors (the people, companies and authorities you owe money to) to freeze interest and even reduce your payments for a short period of time, typically six months, provided you can give them a coherent account of your circumstances, and how and when they'll improve. Debt management plans are for people who:

• have budgeted and snowballed and
• have tried to get extra income, yet
• still have a temporary problem where they can't meet all their debt repayments

These plans aren't legally binding, so your creditors can change their minds, and it will still leave awful marks on your credit record, but it might give you valuable breathing space.

Citizen's Advice and the CCCS can help you to write a debt management plan for free or, if you live in Britain, you could use National Debtline's self-help packs (England and Wales pack/Scotland pack.)

You can also negotiate a full and final settlement. This is in many respects like an IVA  and enables you to close off all or some of your debts by offering, say, 65% of the outstanding debt. However, it can be a little tricky to get right without stitching yourself up and once again it will leave your credit record very badly battered. It's best to take advice on this from one of the debt charities I've already linked to in this article.

3. Formal insolvency procedures

Finally we come to the 'official' stuff. You will always need advice before using a formal insolvency procedure because some of the effects can be severe and it will leave a giant skull-and-crossbones on your credit record.

One of these three formal options would be your last resort. It's important to select the right one for you:

Of all the formal insolvency procedures, bankruptcy is the one that most people want to avoid, yet it is also the one that is most often suitable. Bankruptcy can really be a nasty hit, but it's probably better than you think, and you don't necessarily lose your home. Read more in Is bankruptcy the answer?

Debt relief orders are the new form of bankruptcy for people with low incomes and little in savings. Otherwise, it's pretty much the same as a bankruptcy. Read more in Go bankrupt for less.

Finally, we have IVAs. ('Individual voluntary arrangements', if you want to know.). These are very popular for three reasons. Firstly, some people think going officially insolvent via an IVA is less of a social stigma than going officially insolvent via bankruptcy. Secondly, people think they will automatically lose their homes and all their possessions when they go bankrupt (which isn't necessarily true). And thirdly, lots of companies make a fat load of money selling people IVAs, so naturally they're pushed on us more than bankruptcy.

In reality, a very small percentage of people who need a formal debt solution should get an IVA. Read IVAs unsuitable for 98% of debtors and get advice from a charity before you take one out.

Don't bury your head in the sand

If you need a bit of help to get out of debt, take advantage of the free resources available at lovemoney.com.

First, adopt this goal: Snowball your debts

Next, watch this video: Get out of debt

And finally, why not have a wander over to Q&A and ask other lovemoney.com members for advice on what worked best for them?

Consolidate your debt onto an interest-free credit card from lovemoney.com

More: Eight dealing with debt tips | Five ways to destroy your debt

*in England and Wales. This number will have received a small boost from the new type of bankruptcy called a debt relief order (DRO) but DROs are still relatively few in number and many of the people using them would have declared themselves bankrupt anyway.