A reader asked about a friend who is looking at an Individual Voluntary Arrangement (IVA):
Mr X is 23 and owes just over 10k on various credit cards and loans. He earns £20k and hopes to get a £10k bonus this year. The IVA firm says the bonus doesn’t matter as it’s not guaranteed. But won’t the IVA take half of it? Would it be better if he got a job with a larger basic salary and no bonus, or would they just take more of that?
Let’s start by looking at the facts about how bonuses, overtime and payrises affect an IVA.
That leads to more questions – is an IVA really a good option for Mr X? And has Mr X had proper debt advice?
Bonuses, commission and overtime in an IVA
If a bonus isn’t guaranteed, it isn’t taken into account when your IVA monthly payment is set. But you then have to pay in more when you do get a bonus.
IVAs don’t always have the same clauses – that is why they are called “individual”. But the large majority of IVAs use very similar terms for bonuses. Here is the clause from the 2021 IVA protocol:
you must report any overtime, bonus, commission or similar to the supervisor if this is not included in your original calculation and the amount exceeds 10% of your normal take home pay. Disclosure to the supervisor must be made within 14 days of receipt and 50% of the additional amount (over and above the 10% referred to above) shall be paid to the supervisor within 14 days of the disclosure.
So the reader was roughly right when he said that half of any bonus has to be paid into the IVA.
Not telling your IVA firm is a breach of your IVA contract and it may fail. If you have just forgotten and spent the money, the IVA firm may extend your IVA for more months so the extra can be paid. This may make your 5 or 6 year IVA much longer.
Pay rises in an IVA
If you get a large pay increase, your monthly IVA payments are likely to go up for the rest of your IVA.
How much of your extra income you have to pay to the IVA depends on your IVA terms, but a half has been common and from August 2021 new IVAs that use the standard protocol will say:
You will be required to increase your monthly contribution by 50% of any increase in disposable income one month following [your annual review].
So it makes little difference to what you pay into the IVA if you get a regular bonus each year or your pay goes up by that amount.
It is the increase in your disposable income that matters. A small pay increase “for the cost of living” would often be ignored.
And you may have extra larger costs. Perhaps you have a new job where your commute is more expensive or your hours are different so you have to pay more in child care. All these should be taken into account when calculating how much more money you really have because of the pay increase.
Your IVA won’t end earlier if you pay more
A lot of people go into an IVA thinking that the numbers they have been told at the start are fixed.
For example, if your proposed IVA says you have to pay £120 a month for 5 years, that would mean you pay £7,200 in total over 5 years.
You may think if you pay an extra £1,200 into your IVA because of you have been doing overtime, then you will get to the “£7,200 paid in” point 10 months sooner, so your IVA will end earlier.
That is wrong.
Your IVA will only end early if you have repaid all your debts in full plus the IVA firm’s fees. As a very rough rule of thumb, the IVA fees are likely to be £3,500 or more.
(For IVA starting before 1 August 2021, some people will also have to pay 8% interest per annum on the debt total as well.)
Most people who pay more don’t repay all their debts plus the IVA fees. So for them the extra money just goes into the IVA. The IVA doesn’t finish sooner. And paying in these extra amounts doesn’t mean you pay less later on.
But Mr X doesn’t need an IVA at all!
Mr X’s bonuses are expected to be very large compared to his debts, so if he starts an IVA he will be one of the few people who does pay it all off early.
But even when an IVA is completed early, it still stays on your credit record for 6 years. So for 6 years, Mr X would find it very hard to get a new private tenancy unless he has a guarantor. And very expensive to buy a car on finance.
And when the IVA has gone from his credit record he will still have to declare he had one on a mortgage application as an IVA is a form of insolvency, same as bankruptcy.
For a 23 year old, these are serious problems. If his debt was unmanageable and he had assets to protect, then an IVA would be worth it.
But an IVA has no advantages for him that seem worth paying the IVA fees for – he won’t actually get any debt written off at all.
His better options depend on whether he can afford the minimum monthly payments.
Snowballing if he can pay the monthly payments
If Mr X can afford the monthly payments, then his best option is “snowballing“. Here he carries on paying the normal monthly payments and when he gets a bonus he clear a large chunk of his most expensive debt. Then his monthly payments will drop, and his next year’s bonus should clear the rest of the debt.
He will have paid some interest this way – but it looks likely to be less than the IVA fees, He will also have avoid having insolvency on his credit record, which will end up looking good much sooner.
A Debt Management Plan (DMP) if he can’t
If the monthly payments are too large, then a DMP is a good way forward.
In a DMP, he could make one affordable payment each month. When he gets a large bonus, he can pay more in. Again his debt will be cleared in only a couple of years.
Interest is normally frozen in a DMP, but this isn’t guaranteed. But as with snowballing, any interest would be lower than the IVA fees.
A DMP does harm his credit record, but much less than having insolvency such as an IVA does.
Some firms charge fees for running a DMP. But StepChange don’t, so Mr X should talk to them.
It’s vital to get good advice about an IVA
So why didn’t the IVA firm explain to Mr X how much of his future bonuses he would have to pay in? And why didn’t they point out that he has a better option than an IVA?
It sounds as though they are only interested in the fees they will get from an IVA, not giving good debt advice.
Mr X didn’t need a form of insolvency at all – but good advice is just as important if you do have unmanageable debt.
Too many people are signed up to an IVA when they have no assets at all to protect and a Debt Relief Order or bankruptcy would have been more suitable.
So if you are thinking about an IVA, I suggest you talk to an adviser from a free-sector firm that doesn’t provide IVAs. Go to your local Citizens Advice or phone National Debtline on 0808 808 4000. They can explain the pros and cons of all your possible debt options. And if an IVA is right for you, they will suggest who to talk to.