Rising bills may tip more people into bankruptcy

Published on Friday 8 August 2008 22:11

THE news last week that more people were made bankrupt between April and June this year than in any previous three-month period was predictable but shocking.

Changes to insolvency legislation introduced at the beginning of April, making it easier for individuals to declare themselves bankrupt, ensured that the second quarter of this year was always going to show a rise in personal insolvencies.

However, it was the scale of the increase that was truly alarming. There was a 44 per cent increase on the previous quarter and a 104 per cent increase in the numbers of those being sequestrated against an almost static figure for individuals taking out a protected trust deed (PTD).

The long-term trend is undoubtedly upwards and we predict that around 18,000 Scots will be made bankrupt by the end of 2008 compared with nearly 14,000 in 2007.

The acceptance of severe indebtedness is a comparatively new situation. Just ten years ago, there were just 4,465 personal insolvencies in the whole of 1998 and now we have a higher figure for a three-month period.

Of course there has always been borrowing – on mortgages, cars or home improvement loans – but the past five years has witnessed a marked shift in the level and ease of borrowing.

This period has come to an abrupt halt and those who perhaps over-indulged in borrowing in the recent past now have a severe financial headache to deal with. That the system just made it much easier to clear all debts is possibly an unfortunate coincidence.

With lenders now tightening the screws on their creditors by increasing the cost of borrowing, many already hard-pressed individuals will be facing an autumn and winter of rising repayments of increasingly insurmountable debts.

For example, one credit card company has increased the APR on some of its products to 35 per cent. This rate will be applied to those with the poorest credit record and consequently the least options, resulting in even small amounts of debt accumulating ever-larger interest payments.

We analysed the debt profile of individuals at the point of bankruptcy and found that the average debt was just over 40,000. A 35 per cent APR on a debt of this size will incur interest charges of 14,000 per year. That means that for an individual to have their debt stand still they will be paying just under 270 a week in interest with little hope of ever making a dent in the debt total. Therefore, the option of bankruptcy becomes compelling, particularly now that the discharge period is just a year.

There is also evidence that severe indebtedness has a much wider social profile than before. Homeowners make up a third of bankrupts and people from all walks of life are being affected by debt.

The present combination of higher utility costs, soaring fuel prices and increasing food bills is likely to result in many more people being tipped over the edge into insolvency.

While the changes to the insolvency legislation – primarily the LILA (low income low asset) option – will benefit those with little income or assets, for others the options may not be quite so clear-cut.

Although the most recent figures indicate a shift toward sequestration, for many others a better option would be to take out a PTD. Interestingly, the average pay-out to creditors is higher for PTDs than for sequestration, yet creditors have increasingly been opting for the latter.

There are signs that creditors are keener to send out a message that they are not soft touches for money than to get back more money. But with a PTD, the debtor gets a more controlled form of bankruptcy, which allows them to get back on top of their finances by paying a reduced fixed total negotiated by a trustee over a set period.

This can be helpful for future creditworthiness and can also help individuals eventually regain control of the way they handle money. Easing bankruptcy proceedings may well have been seen as a useful tool to help individuals get out of their financial black hole, but it may also be simply encouraging a cycle of indebtedness and, ultimately, impoverishment. We should be helping people understand that while debt is an inevitable and acceptable part of life, it should be undertaken in a measured way.

• Bryan Jackson is a corporate recovery partner with accountants and business advisers PKF (UK) LLP