However, earlier this year the government introduced an alternative for those living in England and Wales – so-called quickie bankruptcy – for people on very low incomes. These are called Debt Relief Orders (DROs). In Scotland, there is a similar programme called Low Income Low Asset (LILA).
What is the difference between bankruptcy and DROs?
Like bankruptcy, DROs generally last for a year – although the individual concerned will have their name on the Insolvency Register for 15 months in most cases.
However, DROs are significantly cheaper to arrange than bankruptcies. The overall cost of a DRO to the debtor is £90, which can be spread over six months. Filing for bankruptcy, on the other hand, costs in the region of £500.
The latest official insolvency figures show that almost 2,000 DROs were taken out in the second quarter of 2009. That may not seem a lot, but DROs were only introduced in April and are not available to everyone in debt.
To qualify for a DRO, rather than bankruptcy, you must not, for example, owe more than £15,000.
What are the other conditions for taking out a DRO?
Bankruptcy is only usually advised for homeowners as a last resort because any property owned is likely to be sold to pay off the debts built up. With DROs, however, you do not qualify if you have any real possessions of value, meaning that homeowners will not be able to take this route out of debt.
Possessions that do not disqualify you from taking out a DRO include clothes and tools necessary for your job and vehicles worth less than £1,000.
But anyone with savings or a pension fund of £300 or more ,or over £50 of disposable monthly income, will also fail to qualify.
Anyone who has gone bankrupt in the past, or applied for an Individual Voluntary Arrangement (IVA) is also banned from taking out a DRO, as are those who have had a DRO in the last six years.
How will a DRO affect my finances?
Once a DRO is set up, all your debts will be cleared and any calls from creditors will cease. However, not all debts are covered by a DRO. Any unpaid court fines or student loan repayments, for example, are not included, while those with hire purchase arrangements may have to return the goods involved.
During the one-year term of the DRO, you are also banned from taking out additional credit of more than £500 without informing the lender about your DRO.
Anyone found disregarding these conditions, or lying about their income or assets, can be prosecuted and fined, or even sent to prison.
And, as with bankruptcy, a DRO will have an ongoing effect on your credit rating. For more information on the implications of bankruptcy, read last week’s article ‘The real impact of going bankrupt’.
What does the impact on my credit rating mean for the future?
A poor credit score will affect your ability to get credit and other financial products over the coming years.
For example, people with low credit scores do not qualify for market-leading credit card deals such as Virgin’s. It is currently offering new customers who qualify for its credit card 16 months 0% on any balances transferred, with a 2.98% fee, plus 0% on purchases for the first three months.
Instead, if they want a credit card, they must apply for deals aimed at those considered less credit worthy. Current offers of this kind include Capital One’s Classic credit card with a typical interest rate of 34.9% and the Vanquis Visa Card at 39.9%.
The same is true of loans. You must have a very good credit profile to qualify for Tesco Finance’s current 8% personal loan rate, for example.
Those with black marks such as DROs on their files are unlikely to be considered by lenders other than those offering products specifically aimed at this part of the market.
Providers offering loans of this kind include FLM Loans, which has a typical APR of 42.6% but will lend between £500 and £3,000 to anyone with a friend or family member who is a homeowner and is prepared to act as their guarantor.
Current accounts may also prove elusive for people with DROs. Basic bank accounts may well turn out to be the only option available, although some banks may even refuse you access to their simplest accounts.
One bank that accepts undischarged bankrupts, and is therefore likely to accept people undergoing a DRO, is The Cooperative Bank.
Its basic bank account allows customers to pay direct debits as long as there is enough money in their accounts and to make cash machine withdrawals using a cash card.
If having some kind of plastic is important to you, one other option that is open to people with poor credit scores and low incomes is to take out a prepaid card.
The Bread card, for example, can be loaded with cash free of charge at Post Office branches. However, there is a £7.50 application fee, and usage also incurs charges. You will pay a 2% fee when using the card to make a purchase online or in a shop, while cash withdrawals within the UK carry a £1.50 charge.
Please note: Any rates or deals mentioned in this article were available at the time of writing.