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Credit where credit’s due

  • 09/04/2002
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Understanding the impact of bankruptcies and IVAs on your clients' credit record

Is there any flexibility with prime lenders accepting IVAs and bankruptcies?

As a rule, no. Bankruptcies and individual voluntary arrangements (IVAs) signal a major event in an individual’s credit history and most prime lenders are, wisely, reticent to expand their criteria to cover this type of status.

This has lead to the development of a number of non-status subsidiaries from prime lenders and prime lenders purchasing non-standard lenders.

This enables prime lenders to cover all areas of the market in a measured and sensible way. Examples of this growth include Britannia purchasing Platform Home Loans, Abbey National and its non-conforming lending arm First National and Birmingham Midshires, the adverse credit arm of Halifax.

What is an IVA?

An IVA is a flexible procedure where the debtor makes an offer to his creditors which they accept, amend or reject. There are significant advantages of an IVA against bankruptcy. It gives a person more say over how their assets are dealt with and how payments are made to creditors. Individuals avoid the restrictions on trading and obtaining credit which apply to a bankrupt (subject to the conditions of the proposal). The overall costs are likely to be less than declaring bankruptcy, allowing individuals to pay more to their creditors.

An undischarged bankrupt may also enter into an IVA with their creditors. It is better and cheaper to set up an IVA before bankruptcy, but it can be arranged afterwards. However, the approval of the arrangement does not automatically annul the bankruptcy.

What is bankruptcy?

A court makes a bankruptcy order only after a bankruptcy petition has been presented. It is usually presented by the individual (debtor’s petition) or creditors who are owed at least £750 (£1,500 in Scotland) by the individual ‘ even if the individual refuses to acknowledge or agree to the order.

The bankruptcy proceedings free borrowers from overwhelming debts, so it is possible for them to make a fresh start ‘ subject to some restrictions ‘ while making sure their assets are shared out fairly to their creditors. If individuals own their own home it will probably have to be sold to go towards paying their debts.

Anyone can be declared bankrupt, including members of a partnership. Generally, individuals will be automatically freed from bankruptcy (known as discharged) after three years (this is currently under review), or as soon as a court annuls the bankruptcy order ‘ where debts and expenses have been paid in full. Individuals do not get automatic discharge from bankruptcy if they have been bankrupt within the last 15 years. If this is the case, discharges can only be applied for five years after the date of the current bankruptcy order.

How many people are affected by bankruptcies or IVAs?

In 2001, there were over 23,000 bankruptcies and over 6,000 IVAs.

How long does an IVA or bankruptcy order affect an individual’s credit record for?

An individual is freed from bankruptcy after three years, but it can stay on record for up to six years. IVAs have a similar timescale. As both of these credit measures can have a significant impact on an individual’s ability to obtain a mortgage, it is important that brokers understand why either has occurred.

Do IVAs or bankruptcies have a greater effect on an individual’s credit record than other aspects of their credit history, for example CCJs?

Most lenders, including non-conforming ones, consider bankruptcies and IVAs as a severe financial problem. Although county court judgements (CCJs) are relevant, the individuals in question are not considered a bad credit risk.

Although the same does apply to bankruptcies and IVAs, the severity of the credit problem will lead lenders to examine the case in more detail. The most important thing for lenders to determine is the individual’s ability to pay in their current situation.

How do non-conforming lenders measure an individual’s credit risk?

The one major difference between prime and non-conforming lenders evaluation of credit risk is the lack of credit scoring in the non-conforming market.

A non-conforming lender’s goal is to obtain a full picture of an individual’s credit history. This includes any CCJs, IVAs or bankruptcies. By manually underwriting each case the non-conforming lender has the flexibility to determine the risk of each applicant.

What do non-conforming lenders consider as too much of a risk?

Because of the manual underwriting procedure the main determinant is a borrower’s current ability to pay. Although factors such as bankruptcies play a part in determining an individual’s propensity to default, the current situation is much more relevant.

What information should a broker collect if an applicant does have a bankruptcy or IVA?

Brokers should try and switch from a ‘tick box’ approach they would use for a prime applicant and instead focus on an individual approach. It is important that lenders receive a full background on why the credit event occurred and are reassured the borrower will be able to pay the mortgage.

Along with these explanations supporting information is also required. Although borrowers may not be keen to talk about this aspect of their past it is in their best interests to be as truthful and open as possible.

Paul Thomas is chief operating officer of Mortgages plc


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