Solution to personal insolvency lies in bankruptcy’s shadow
This is because these arrangements involve the creditor bringing something to the table and this means being in a position to pay part of the debt. If the borrower is unable to do this, an arrangement becomes impossible.
Take somebody with an unmanageable debt of €100,000. In a DSA they would pay something over a period of five years after which the residual debt is written off. The amount might be €500 per month meaning a payment of €30,000 over five years. This involves a write-off of over €70,000 plus interest.
The key is the creditor being able to pay €500 after minimum living standards.
The cruel fact is that there are huge numbers of people who are living at or below minimum standards, and therein lies the conundrum.
But this is a huge opportunity for people. The solution is bankruptcy and often the only bad thing about bankruptcy is the word bankruptcy.
In bankruptcy, which is an insolvency process, debts are written off in full regardless of whether the borrower can make any payments and regardless of whether the banks agree.
In our example above, the borrower will make no payments — life will go on and in three years the borrower will be debt free.
It is very important that people understand how bankruptcy works because it is bankruptcy which is the benchmark for all insolvency decisions.
Lets take a more complicated example involving a family home.
Borrower X has a mortgage of €500,000 on a family home worth €300,000. He also has a buy-to-let with a mortgage of €300,000 on a property worth €150,000. He therefore has debts of €800,000 and property worth €450,000. He has a gross income of €70,000 and is unable to pay his debts as they fall due.
The banks may offer deals on the buy-to-let and on the family home, but the result will be that X will live on a minimum standard and be on the hook for the full amount forever.
If his circumstances change for the better, the bank will take all of the improvement. And in the end, the bank will force the sale of the properties and the borrower will be left with nothing.
What is the position in bankruptcy? At the moment of adjudication X’s debts and assets become the property of the assignee (a civil servant). The assignee looks at X and sees that the assets have no value because of the negative equity.
He looks at X’s income and applies the minimum standards test. If there is a surplus the assignee takes the surplus. On a gross income of €70,000 there will very little, if any, surplus. Any valuable asset will get taken — though the sort of asset taken is above and beyond most people. So life goes on for X as though nothing has happened.
On the property side the negative equity portion is written off. He hands back the keys of the buy-to-let and the problem is immediately solved.
But X wants to keep his family home — can he? The assignee has stated that he will release a negative equity property for a fee of around €5,000. Its a kind of ransom, but there you go. X agrees to pay the €5,000 over time.
X goes to the bank and looks to do a deal.
His position is now much stronger because he now no longer owes the negative equity. If the bank repossesses the property, it will get the value of the property, minus all the costs of repossession, but it will get nothing else. The bank takes a hit of over €200,000 on day one and banks do not like this.
If X can pay a mortgage of €300,000 the bank is getting more that it will in bankruptcy. And usually borrowers have other unsecured debts, all of which have just been written off. So the borrowers ability to pay a mortgage is strengthened.
Perhaps the deal could be a mortgage of €300,000 with a further payment of €100,000 on the sale of the property or on the death of X. Either way, the borrower’s position is greatly strengthened. The position is further strengthened if X is married.
But the real strength is in numbers.
The banks can deal with hundreds of bankruptcies by playing hard ball. But if, as we expect, tens of thousands of people realise the power of bankruptcy, the game changes and banks will start to do deals. All they do now is medium-term mercy.
In the end the banks want it all.
At New Beginning we believe that the solution to the debt problem lies in the power of bankruptcy. Not every insolvent person need take this course but its presence rebalances the relationship like nothing else. It is in the shadow of the threat of bankruptcy that real deals get done.
And deals are good for borrowers and good for the economy. Ultimately what’s good for the economy is good for the banks — but banks will never understand this.
People must take control.
* Ross Maguire is senior counsel with New Beginning.
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