Informal or formal arrangement with my creditors?

What is the difference between a formal and an informal arrangement with my creditors? a reader asked. This post looks at what the alternatives are and how to decide which is better for you.

If you pull on a pair of jeans and a T-shirt, then it’s easy enough to add a jumper if it gets chilly or switch to old trainers if your new shoes are rubbing. But you need to plan formal dress more carefully in advance as you can’t change it so easily half way through the evening. And it’s much the same with debt arrangements: informal arrangements are easy to start, stop and adapt – the formal debt solutions aren’t.

When do you need an arrangement with your creditors?

If you can afford to make the minimum monthly payments on your debts, you don’t need an arrangement at all: read up about “snowballing” your debts  and improving your finances to clear them faster.

But if you can’t afford the monthly payments, then keeping your creditors informed of your situation and what you can (and can’t!) afford to pay is called “making an arrangement with your creditors“. It may seem scary but it will make your life easier than hiding from the situation. Creditors hassle people who they think may be “won’t payers” much harder than they do people who have shown that they are genuinely “can’t payers”.  If you would like help to deal with your creditors, look at Where to get Help and Advice .

DMPs – informal arrangements with creditors

A Debt Management Plan is an informal arrangement with your creditors. You make an offer of what you can afford to pay each month (sometimes this may be nothing), enclose details of your Income & Expenditure so they can see this is fair, and ask them to freeze interest and stop adding charges.

This is “informal” because you are asking them to agree. There is no formal legal agreement or court decision to make your creditors accept your offer. In practice most creditors usually agree initially, see this article. They can however change their mind later, or sell the debt on to another company.

The big advantage of an informal arrangement is that it is easy to change if your circumstances alter. So if you just have a temporary problem – until you can find a new job having been made redundant, or until your youngest starts school and your childcare costs reduce – then debt management should be your first choice.

If after 6 months or a year your utility bills and other expenses have risen and your hours at work have been reduced, then in a DMP you can reduce the amount you pay each month, again supplying details of your situation to your creditors.

Types of formal arrangements

Here are links to pages describing the main types of formal arrangements:

• Debt Relief Order (DRO) – you have to owe less than £20,000, not own assets and have less than £50 a month surplus income after paying all your normal expenses. It formally ends most types of debt.
• Individual Voluntary Arrangement (IVA) – although this is called ‘voluntary’ it is a formal legal agreement, where you make monthly payments for 5 years or 6 years if you have a house. The majority of your creditors have to agree to accept an IVA – it is then binding on all your creditors.
• Bankruptcy – it formally ends most types of debt. You used to have to go to court to go bankrupt, but from 2016 it is just an on-line application. Most people don’t have to make any monthly payments if they go bankrupt.
• Full & Final Settlements – if your creditors agree to accept your offer, they can’t seek to recover the rest of your debt, so this works like a formal agreement.

Formal arrangements can’t be changed easily

The key difference between formal legal arrangements and the ‘informal’ debt management, is that the formal arrangements can’t be easily ended or changed, either by you or by your creditors.

For debts that would take a long while to clear in a DMP, a formal arrangement will give you the security of a definite solution to your debts within a set timescale. This is their major advantage.

The flip side of the coin is that it is also their major disadvantage because you can’t get changes made easily either:

• if you think your situation might well improve, then this means that formal solutions are not generally a good idea;
• if you think your situation might deteriorate, then you would be very unwise to agree to the lengthy five or six year IVA because it may be impossible to change the agreed payments and your IVA will fail..

In Bankruptcy, you can make changes to your monthly payments if your circumstances change and these payments only last for three years. But it is extremely expensive to ‘end’ bankruptcy if your finances improve considerably. This is why you should never let a creditor make you bankrupt if you have any other sensible option.

So formal or informal?

As a rough guide, the more you owe and the longer it will take to repay, the more you should look for the certainty of a formal debt arrangement. But if your situation may change, for the better or worse, then opt for the flexibility of a DMP.

---