Sunday Times Money: Finding a way back to black

sunday times

As the launch of the insolvency service draws near, specialists look at scenarios that debtors may face

Niall Brady, Sunday Times –  Published: 28 April 2013

Debtors must wait until the Insolvency Service of Ireland (ISI) opens for business at the end of June to discover the extent of debt relief that will be available from banks and other creditors.

Debt experts are studying how the proposed insolvency regime will operate, to ascertain how unsustainable debts will be treated.

We asked two debt experts, Paul Carroll of Neo Financial Solutions and Steve Tennant of Grant Thornton Debt Solutions, for their opinions of what our sample debtor might expect from the new system.

The sample debtors

Peter and Alice had a family retail business and in 2004 they decided to move house, taking advantage of the strength of their thriving business. They sold their old home and, with a new mortgage of €500,000, they bought a new home for €1m.

By 2009 their business was struggling. It had run up a €70,000 overdraft and owed €30,000 in unpaid taxes to Revenue. The couple’s bank wanted to convert the overdraft into a term loan of €100,000, giving them enough to pay the Revenue arrears.

The bank insisted that Peter and Alice gave personal guarantees to secure the loan. After 18 months the business failed, leaving Peter and Alice owing €100,000 to the bank and €100,000 to creditors, which they had also personally guaranteed. The couple have unsecured debts of €25,000, comprising a credit union loan of €15,000 and credit card borrowings of €10,000.

Since the business folded, Peter and Alice have secured employment. They earn a combined income of €6,200 a month after tax and including child benefit for their children, aged 10 and 16. They have taken steps to reduce spending.

They are unable to pay their mortgage and contribute very little towards their other debts. The value of their home has fallen to €300,000, putting it into negative equity.

At their current debt levels, there is no chance of reaching an agreement with creditors that would be sustainable in the long term. Peter and Alice decide to investigate their options under the new Personal Insolvency Act.

Our experts recommended two different approaches to the debt problem.

Carroll suggested a personal insolvency arrangement (PIA), designed for secured and unsecured debts. This would result in a write off of €303,000 of the debts. Without debt forgiveness on this scale, Carroll believes bankruptcy might be the best option for our sample debtor, even though this would result in the loss of their home.

Tennant believed a debt settlement arrangement (DSA) would be the most likely outcome. DSAs are for unsecured debts only, although they could be used to deal with shortfalls that will result when debtors agree to voluntarily restructure their mortgages with banks.

Under this scenario, only €150,120 of the debtor’s borrowings would be written off.

The extent of debt write-offs will depend on the level of repayments made during the insolvency process, five years for a DSA, up to six years for a PIA. Agreeing these repayments will depend on the allowance made for reasonable living expenses while in the insolvency process.

Paul Carroll: personal insolvency arrangement

As they have secured mortgage debt and unsecured debt (the term loan, business creditors, credit union and credit card debt), a PIA is appropriate for Peter and Alice. It would protect their home while providing a sustainable solution to get rid of their excess debts.

On their income, Peter and Alice could expect to pay 35% of take-home earnings on either rent or a mortgage under an insolvency arrangement. This equates to €2,170 a month, enough to sustain a mortgage of €350,000 over 20 years at current interest rates.

ISI guidelines suggest the family should live on about €5,000 a month, including the revised mortgage of €2,170. Allowance has been made for two cars because they cannot get to work on public transport. The budget also includes private health insurance because Peter has a pre-existing medical condition.

After the mortgage and living expenses, Peter and Alice would have a disposable income of €1,200 a month.

A personal insolvency practitioner would propose that the mortgage be reduced to the sustainable amount of €350,000 — leaving a shortfall of €150,000.

The practitioner would also propose that the borrowings of €200,000 from the failed business and the unsecured debt of €25,000 be written off in full, bringing the total shortfall to €375,000. Under the PIA, Peter and Alice would pay €1,000 a month from their disposable income of €1,200 to their creditors for six years, a total of €72,000. This would reduce the shortfall to €303,000, which would be written off at the end of the PIA.

The payment of €1,000 a month would be distributed to creditors by the insolvency practitioner after the deduction of his fees (expected to be in the region of 15%).

The arrangement would be reviewed annually to take account of exceptional changes in income (a lottery win, an inheritance or redundancy) which might affect the amount Peter and Alice could afford to pay over the course of the PIA.

They would pay the revised mortgage of €350,000 until the end of the loan term. If they sold their home during the PIA for more than the amount owing on the mortgage, the bank could be entitled to up to half of the difference. However, if they delayed the sale until the PIA is complete, there would be no clawback.

Banks have the power to veto a PIA, so why would they accept this deal? Because it leaves them in a better position than if Peter and Alice were forced into bankruptcy. Under this agreement, the banks would receive regular payments for the six years of a PIA, which they would not get if they forced the couple into bankruptcy.

Steve Tennant: debt settlement arrangement

A personal insolvency practitioner would assess the couple’s financial situation and consider their options under the legislation.

It is envisaged the mortgage could be restructured consensually with the bank outside the formal insolvency process.

The unsecured debt that remains after restructuring would be dealt with through a debt settlement arrangement (DSA). The practitioner would set the family’s reasonable living expenses at €2,400 a month after mortgage payments, which would be €250 more than allowed for under the ISI’s guidelines.

The practitioner would contact the bank and agree to split the mortgage, putting €175,000 of the balance on interest-only payments for the five-year term of the DSA. This would reduce the cost of the mortgage to €2,552 a month, a saving of €477 a month.

After paying living expenses and the mortgage from their net income of €6,200 a month, Peter and Alice would have €1,248 left to pay their creditors. Over the five years of a DSA, this would amount to €74,880. At the end of the arrangement, there would be a shortfall of €150,120 of unsecured debt which will be written off in accordance with the legislation.

Repayments of capital would begin on the €175,000 of mortgage debt that was on interest-only for the duration of the DSA, increasing the monthly cost of the mortgage by €711.

Peter and Alice would be better off, however, because the extra mortgage payment would be less than the €1,248 they paid their creditors during the DSA.

For the arrangement to work, 65% of creditors must approve a DSA. This requires the debtor, bank and other business creditors to agree to the proposals.