If you’re in debt and looking at your various options, the number of acronyms and technical terms might seem intimidating. What is a debt management plan (DMP), and how can you get one? Should you consider an individual voluntary agreement (IVA) instead? What’s the difference between a DMP and IVA? Who is involved in helping you manage these processes?
Don’t worry – we’re here to break down the confusing terms so that you know exactly what they mean. Hopefully, once you’ve read this article, you’ll be in a good position to know what you need to do to sort out your finances and, with a set plan, get back in the black.
- When to seek debt help
- What is a debt management plan?
- Individual voluntary agreements explained
- More debt help
Facing debt is a scary prospect – but, like the laundry or the washing up, the longer you leave it, the more of a task it becomes. The moment you feel overwhelmed and unable to meet your monthly repayments, seek debt help.
It could be something as simple as requesting a payment holiday, if you’ve been affected by the recent pandemic. Or, you could ask your creditors to freeze your interest payments for a couple of months to give you a little more breathing space. In some circumstances, a consolidation loan could help you avoid any defaults on your credit file and give you time to repay a manageable amount each month.
However, if you feel that you won’t be able to recover from your debt problems within a short space of time, you’ll need to seek extra help. Try contacting charities like Community Money Advice to learn more about financial management, budgeting, and debt help, as a first step.
A debt management plan is for those with smaller debts to repay. They’re often the first port of call for people struggling with debt following a life event, such as redundancy or illness, and buys some extra time for you to repay your debts to your creditors before any legal action.
Who is involved?
A debt management plan is privately agreed between your creditors (the people you owe money to) and yourself, sometimes with the help of experts from charities like StepChange. Charities will set up your debt management plan without charging a fee. There are some companies that offer to do the same for a fee – don’t do it! They’ll do the same as the charities will – and StepChange and National Debtline are for anyone, so there’s no need to pay for a DMP.
How do debt management plans work?
When drawing up the plan, all of the interested parties negotiate and agree on a rate for you to repay each month. This might involve freezing interest on your debts, in order to make them more manageable (but it won’t always). A ‘Token DMP’ is often the first step: for many, this means 12 months where you pay just £1 a month and your interest is frozen. This means you’ve got a year to work on building a fund to pay your debts off – it breaks the ‘work-expenses-debt-interest’ cycle and gives you breathing space. It’s especially useful if you’ve just lost your job or income, as it buys you time to find other ways of earning money.
The charity that is helping you will divide up the money you pay to them and distribute it between your creditors for you, saving you a lot of hassle and meaning you don’t need to pay companies back individually. They’ll not give an equal portion to each creditor. Instead, they pay a proportion of your monthly payment – so the biggest debt gets the largest percentage. This is so that you can whittle down each debt at a rate that’s acceptable to your creditors AND makes sure each debt is paid off in good time.
Is a debt management plan legally binding?
A debt management plan is not enforced by a court. It will affect your credit rating, but not in the same way that an IVA will (see below for more on that). Every creditor will record a default on your credit score each month that you don’t repay your debt in full. These defaults will stay on your record for up to six years. When you’ve paid off your debt, it’s marked as ‘satisfied’ rather than ‘settled’, to show there had been defaults but the debt is paid off.
Benefits of a debt management plan
A debt management plan should be your first port of call if you’re looking to pay off debts that have got out of control. Some of the benefits include the following:
- You only pay back what you can afford
- One monthly payment, meaning it’s easy to keep track
- Because a debt management plan isn’t legally binding, you have greater flexibility in how and when you repay your creditors
- It can avoid you having to take out an expensive and strict formal arrangement, such as an individual voluntary agreement
Negatives of a debt management plan
Of course, the flexibility of a debt management plan can work against you, too. Because the plan isn’t legally enforced, if you can’t make your repayments or have trouble keeping track of what you owe you could end up not paying off your creditors as planned. The onus is on you to stay on top of your money with a debt management plan.
Other potential negatives include:
- Your creditors can still contact you, and they may still up your interest or demand that you make larger repayments
- If you’re only paying off a small amount every month, this could see you being charged more interest and you paying more in the long term
If you’re in debt, start with a debt management plan. If that doesn’t help and you don’t manage to clear your debts, you may move to an individual voluntary agreement in order to try and avoid bankruptcy.
Who is involved?
An individual voluntary agreement is enforced by an insolvency practitioner and agreed by the courts. An insolvency practitioner might be an accountant or a lawyer with specialised skills in this area. You can’t arrange an IVA yourself – you have to use an insolvency practitioner. Again, StepChange and National Debtline can help you set up an IVA.
How do individual voluntary agreements work?
Individual voluntary agreements are a bit like bankruptcy, but are not as extreme. Often, they are used as a way to avoid individuals having to declare themselves bankrupt.
Having an individual voluntary agreement will definitely affect your credit score, but you could recover faster than bankruptcy. It won’t affect other things either, such as your legal right to become a director of a company as bankruptcy would, for example.
You have to have debts above a certain amount (sometimes as low as £5000, but often £15,000) to be eligible. The amount depends on the practitioner you use. The good news is that a lot of this debt is likely to be written off if you can’t afford to repay all of it within six years.
How the debt is managed
Unlike a debt management plan, where you choose to repay the money, an IVA practitioner basically controls your money for you. Similar to bankruptcy, you’re on strict living-expenses-only until the IVA is over. Almost all surplus goes towards your debts.
The agreement will see you pay back the debts that you have to your creditors over a period of time, usually in monthly chunks. At the end of six years, if you’ve not repaid your whole debt, the rest is written off. This means it’s much longer than bankruptcy (which is usually a year long), but is far less damaging in the long-term than being a bankrupt.
Is an individual voluntary agreement legally binding?
Yes, it is legally binding and is enforced by a court. This means that you have to stick to your repayments. The good news, though, is that your creditors do too – so once the agreement is in place they can’t demand the debt is repaid any more quickly or in larger amounts. This makes it different to a debt management plan, which is less formal.
Benefits of an individual voluntary agreement
There are numerous benefits to an individual voluntary agreement:
- An individual voluntary agreement can help you avoid bankruptcy
- It can get your debts in order so you have a set amount going out each month
- Can ensure that your creditors don’t continue contacting you asking for repayment
- Doesn’t affect your right to become a company director in the future
- It’s a limited time – between 1 to 5 years
- You won’t have to sell your home (but may be required to remortgage to release some equity)
- You retain some pride: you’ll repay at least some of your debts
- Your name won’t be published in the papers as a debtor (unlike with bankruptcy, which is public)
Negatives of an individual voluntary agreement
Of course, there are negatives to have an individual voluntary agreement too – but this is hard to avoid. Getting out of debt is never going to be a completely easy ride! Here are some of the things that you need to be aware of if you’re going to enter into an individual voluntary agreement:
- The cost of taking out an individual voluntary agreement can be high (this is the time that the insolvency practitioner will charge you for)
- Your credit rating will be affected (although not as highly as if you were to go declare bankruptcy)
- Because the individual voluntary agreement is legally binding, if you can’t stick to it you could find yourself in trouble
- It’ll affect things like being able to get a mobile phone contract, overdraft, new bank account etc
- Your money is scrutinised by your practitioner
We hope this has helped you become a bit more clear about the differences between a debt management plan and an individual voluntary agreement. Now, it’s time to consider your own finances and decide which is the right path for you.
Have you cleared your debt by taking out an individual voluntary agreement or a debt management plan? Let us know over on the forums.
The most important thing when you’re facing a debt mountain is to arm yourself with plenty of information. It’ll help you take control of the situation! Read these articles for more guidance about managing debt.