If you’ve been struggling to repay your debts off late, you need to seek debt help or advice from a professional as soon as possible. Financial problems and debt issues can cause a lot of stress and severely affect your mental well-being. Ignoring debt problems only makes them worse. So, the only way to proactively deal with them is to face them head-on and find a debt solution that works best for you.
Figuring out which debt solution works best for you can be challenging. People often ask us ‘how to get out of debt?’ or ‘how can we write-off debt?’ There is no fixed answer to that question A host of factors influence the answer to this question. Individual circumstances can have an immense impact on the type of debt solution you choose.
Individual voluntary arrangements or IVAs are one of the most popular formal debt solutions in the UK. Introduced by the UK government in 1986 as an alternative to bankruptcy. IVAs grew in popularity because they allowed some borrowers to write off a part of their unsecured debts. On the other hand, debt consolidation loans are an informal solution that can help some borrowers regain a measure of control over their finances.
Before you settle for a solution, you need to understand all the different options available to you. In this article, we’ll be looking at individual voluntary arrangements (IVAs) and debt consolidation loans in detail. We will also compare these solutions and explore the key issues you should consider before going for an IVA or taking out a debt consolidation loan.
What is an Individual Voluntary Arrangement?
An individual voluntary arrangement (IVA) is a formal and legal agreement between you and your creditors to help you repay your debts at an affordable rate over a fixed period of time, usually five or six years. During this time, you will repay an agreed lower amount towards your debts. This amount would then be split between your creditors.
After your IVA term elapses, the remaining unsecured debt (this can be as much at 90% of your debt) will be written off. It is worth noting that an IVA is a formal agreement that can only be negotiated and set up by a licensed insolvency practitioner (IP).
IPs are professionals (mostly accountants) authorised to represent and assist insolvent individuals and businesses when they are under financial distress. Once your IVA is in effect, your creditors will not be able to communicate with you. Your IP will handle all correspondence with them and deal with them on your behalf.
What is a Debt Consolidation Loan?
Debt consolidation is an informal debt refinancing method that helps some borrowers manage their debts in a better way. It involves combining different debts into one individual ‘lump sum’, which is then repaid to a single creditor every month.
One way to consolidate debt is to take out more credit in the form of a debt consolidation loan. A debt consolidation loan is usually a large loan taken out to pay off existing loans. Once multiple loans are consolidated and repaid, the borrowers only have to make payments to one creditor.
Debt consolidation loans make it easier for some borrowers to manage debt repayment effectively. However, debt consolidation is not for everyone since it involves taking new credit to repay existing loans and can make your debt problem worse in the long run. That is why it is very important to discuss your options with a debt advisor.
Key Issues: IVA or Debt Consolidation Loans?
- Total Cost
IVAs are popular in the UK because they allow borrowers to write off some of their debt. Once you complete your IVA successfully, your creditors will write off your remaining debt. How much of your debt gets written off depends on your circumstances, debt level, and affordability. Some people have been able to write-up up to 90% of their debts with an IVA.
Debt consolidation loans can be more expensive than IVAs in the longer run. While monthly payments, interest, and charges are reduced when you take out a consolidation loan, you may end up paying more than your initial loan because of a longer-term. Initially, if you have multiple debts totaling up to £20,000 and you take out a loan over 5 years (same duration as an IVA) at 10% interest, you may have to repay more than £25,000.
- Homeowner’s Risk
Once an IVA has been set up, homeowners do not have to face a greater risk of repossession. In fact, once you enter an individual voluntary arrangement, all your assets are legally protected. If you have to make mortgage payments every month, allowances are made in determining how much you can repay during your IVA.
Taking out a secured debt consolidation loan is different from arranging an IVA because it increases the risk of repossession, especially if you fail to make repayments. When you take out a secured debt consolidation loan, you are effectively decreasing how much of your house you own. If you default, your lenders can repossess your house.
- Credit Rating
If you take out a debt consolidation loan and manage to repay your debts in full, you will not be violating any agreements and your credit rating will remain unaffected. However, serious problems can arise if not all your debts are repaid or you borrowed more than you needed and spent the rest. This results in you accumulating more debt than what you had in the first place. Since you’re paying back less, you may be more inclined to borrow more – until you need to consolidate again. This vicious cycle can lead to a debt trap which will adversely affect your credit score.
If you opt for a legal insolvency solution like IVA, it will continue to appear on your credit file for six years. However, since IVAs allow you to write off debt you cannot afford to repay, it will be easier to rebuild your credit afterward. Throughout the duration of your IVA, you will also not be allowed to borrow more money.
- Equity and Assets
One of the main advantages of an IVA is that it does not require any equity or assets. An IVA allows you to manage your debt and even write it off while protecting your assets. With individual voluntary arrangements, you do not have to worry about losing an asset of value.
At the same time, it is becoming increasingly difficult to borrow large sums of money without securing them against an asset. If you have 15,000 of unsecured debt, you probably won’t be able to consolidate it with an unsecured debt consolidation loan.
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