Debt advice in an age of inflation

At the beginning of 2021, UK inflation was under 1% but by the end of the year it was about 5%. In May 2022, it was up to nearly 9%.

More than 20 million household say their energy bills go up by over 50% in April. Petrol price increases are hard for anyone commuting to work by car or living in a rural area. And of course rising food prices are affecting everyone.

When it raised UK interest rates in May 2022, the Bank of England warned inflation may be up to 10% in October, when the next round of energy price increases hits.

This article looks at two things.

First, the implications of inflation for people with unmanageable debts. For people with tight finances now, the wave of price rises makes problems much worse.

Second, how inflation will affect the debt advice process.

Inflation makes debt problems worse

Many people are finding their income doesn’t rise as fast as prices do.

In April 2022, benefits went up by about 3% – despite inflation running at nearly 9%.

And many of the items that increased in April such as energy bills and council tax are priority debts. They have to be paid first, leaving you with less money to pay your consumer debts such as credit cards, loans, catalogues and BNPL.

So inflation can often make a tight money situation much worse.

It’s important that you don’t make any commitments now that you will find it hard to meet if your energy bills and other prices shoot up. In particular:

• try to avoid Klarna and the other BNPL accounts. You only have a very short term to repay those purchases and they may make your situation worse next month.
• don’t start an IVA unless your IVA firm puts it in writing that your monthly payments will be reduced by the amount your expenses go up this year. Vague assurances that this will be considered is not good enough … A  third of IVAs fail because people can’t make the payments – you do not want this to happen.
• don’t take out a secured loan to consolidate cards and loans. This may sound cheaper than the cards, but it puts your house at risk if rising prices mean you can’t make the repayments.
• don’t borrow money from family, as you may not be able to repay it. And don’t involve your family in your problems by asking them to be a guarantor.

Instead, it is a good idea to talk to a trustworthy debt adviser about your situation. Debt advisers can help not just with the debts but also with suggesting grants and other help you may be eligible for.

Some implications of inflation for debt advisers

1) Increasing demand for debt advice

The demand for debt advice is likely to rise as after-tax incomes do not keep pace with inflation. The freezing of income tax thresholds and increasing National Insurance in April means that someone getting a 5% pay rise will be worse off if their expenses all go up by 5%.

Unless the government takes comprehensive action to reduce the energy bill increases, there won’t just be more people with debt problems, there will be more people with priority debts and complicated cases. All part of a debt adviser’s job, but it does mean the workload may increase a lot. Let’s hope MaPS sort out sustainable funding arrangements for face-to-face advisers soon!

2) Uncertainly in assessing disposable income over the rest of the year

If you are drawing up an Income & Expenditure statement now for a client, how much extra should you allow for likely price increases in the next few months?

The worst case to get wrong is where future inflation could make an IVA fail. Free sector advisers should not recommend an IVA unless it is likely to be sustainable for at least the first couple of years.

It seems unwise to rely on an IVA firm giving good advice in this situation. I heard recently of a client whose IVA had been set up the month before the £20 a week Universal Credit uplift was withdrawn in October, after which he qualified for a DRO.

If a client will qualify for a DRO if prices go up much, then a temporary DMP and checking in with the client in 3-6 months may be the best way forward.

3) clients whose existing debt solutions become unsuitable

DMP and IVA monthly payments may well become unaffordable and clients cannot manage until their next annual review. I suggest DMP and IVA firms should be pro-active, telling clients to get in touch if they have been badly affected by increased prices.

IVA firms need to be prepared to reduce payments, not offer breaks as there is little sign that prices will reduce in future. And IVAs should not simply be extended. turning a 5 year IVA into a 7 year IVA makes the hardship carry on for too long.

When an IVA becomes unsustainable, IVA firms should propose that it is completed on the basis of funds paid to date, even in the early years of an IVA. Where a client has been paying as much as they can afford, what is the benefit to the client or creditors in failing the IVA and leaving them back with their debts, making them go through another form of insolvency?

Update: in June 2022, IVA Guidance was published allowing firms to reduce monthly payments by much more and saying that firma should consider complaeteing IVAs on the basis of funds paid to date in some cases. See Help with IVAs if you can’t pay because of the cost of living for details.

4) Debt-specific numbers

Some debt solutions and processes have specific financial numbers included that may need to be updated for rising prices.

In 2021, the Insolvency Service increased various limits relating to DROs. But general debt levels will increase with inflation and the new total debt limit may no longer be adequate soon. The doubling of the permitted car value to £2,000 already looks insufficient, with used car prices going up in 2021 by nearly 30%.

UPDATE – in March 2024 it was announced that the maximum debt limit in a DRO would be increased again to £50,000. And the value of a permitted car is again doubling to £4,000.

5) CPI doesn’t tell the full story

The other numbers that are important for debt advice are the spending guidelines in the Standard Financial Statement (SFS). The SFS says:

The guideline figures will be updated annually to reflect changes to expenditure patterns based on data taken from the annual ONS Food and Living Costs survey and / or any significant fluctuations in the Consumer Price Index. This will ensure that the real value of the expenditure figures is maintained over time. A 3% positive or negative variance in real inflation from the forecasts applied to the SFS will be notified to the Governance Group, while a 5% positive or negative variance will trigger a review of the current figures.

But the problem here is that CPI is not a good indicator of the actual increase in expenses faced by many debt advice clients, as their expenses do not match the basket of products used to calculate CPI.

The Joseph Rowntree Foundation says that after the rises in April:

Energy bills would amount to 6% of the average income of a middle-income family but 18% for a low-income family. This would rise to 25% for lone parents and couples without children, while single-adult households on low incomes could be forced to spend 54% of their income on gas and electricity.

  Jack Munro points out that:

[CPI and RPI] only tell a fragment of the story of inflation, and grossly underestimate the true cost-of-living crisis

and she is compiling the Vimes Boots price index, named after the Terry Pratchett character, which will:

document the disappearance of the budget lines and the insidiously creeping prices of the most basic versions of essential items at the supermarket.

Perhaps MaPS should be looking at this new price index to assess the guidelines in the SFS.

Update: the ONS is planning to make some changes to the way it reports inflation statistics.

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