When I am advising people about debt management, they will often ask me whether there are differences in how their credit rating will be affected if they undertake a debt management plan, individual voluntary arrangement (IVA) or declare bankruptcy. All of these different solutions are designed to help people who are already in a position where they cannot afford to repay the debt they owe. As such, it stands to reason that if any of these solutions are carried out, action will be taken to stop the individuals using them from taking further credit.
The main action by creditors to prevent further credit being taken will be the issuing of a default notice against the individual. A default notice is simply a formal acknowledgement that an individual has broken a repayment agreement with a creditor. This notice will be registered on the individuals credit file and will therefore be visible to anyone considering lending to the individual in the future.
Generally a default notice will be issued by a creditor whether or not an individual chooses to deal with their debt using a debt management plan, individual voluntary arrangement or bankruptcy. As such, the question should not be if an individual’s credit crating will be effected undertaking these solutions but rather, how long the effects will last. This will differ between the different solutions.
The first solution to consider is a debt management plan or DMP. A DMP reduces the amount that an individual pays their creditors each month to an affordable amount. However, a significant disadvantage of the DMP is that there is no agreement for creditors to write off any of the debt owed. As such, it will generally take a long time to pay off in full. By definition, if an individual enters into a debt management plan with their creditors, they will be breaking the original credit repayment agreement. As such must creditors will issue default notices. These notices will generally remain on the individuals credit file until the debts are settled or paid off in full. As such, using a debt management plan will mean an individual’s credit rating will remain adversely effected for many years (until the debts are repaid).
In an individual voluntary arrangement (or IVA) default notices will be issued against the individual in debt in the same way as with a debt management plan. In addition, the fact that the individual has entered into an IVA will also be recorded on their credit file which will generally have a negative effect on a credit rating. However, the IVA has the significant advantage of being a finite solution. Generally after 5 years, the IVA will be completed. At this stage a notice of satisfaction will be recorded on the individual’s credit file. The notice that the IVA existed will remain on the individual’s credit file for 6 years. However, from the date that the notice of satisfaction is issued, any potential lenders are aware that all historic debts have been settled and they can begin to consider the individual as a better lending risk.
If an individual chooses to declare bankruptcy, as with the IVA and debt management plan, default notices will be issued. In addition, the bankruptcy will be recorded on the individual’s credit file which, as with IVA, will have a negative effect on their credit rating. As with an IVA, the notice of the bankruptcy will remain on the credit file for 6 years. However, in general an individual will be discharged from their bankruptcy after 12 months. A notice of discharge will then be recorded on their credit file and from this point potential lenders may start taking a more favourable lending view.
Having analysed how an individual’s credit rating will be affected by carrying out each of the different debt management solutions, one could conclude that if the intent is to get back into a position where borrowing is an option as soon as possible, then bankruptcy is the best solution to choose. Clearly however, this is not the only issue under consideration when deciding which debt management solution is the correct one to undertake. In addition, the way that potential lenders will react to an individual who has got into difficulty with credit in the past is difficult to predict. This has become even more problematic in the light of the current credit crunch and the general reluctance of banks to lend money to seemingly even the most credit worthy individuals. In light of this, if you have a debt problem, my recommendation is that that your first priority should be worry about resolving the problem in the best way. Being able to borrow again at a later date should actually be a secondary consideration.