Go bankrupt for less

Read about a new way to clear all your debts when you're unable to pay them and you're suffering from severe distress or irresponsible lending.

As a finance journalist I've read the stories of thousands of debtors, so I know how most of them feel. Despite the concerns of a number of readers who think bankruptcy is all too easy, the majority of people who go bankrupt really do not want to. They are ashamed. They feel they've failed. They feel they're doing something wrong. Almost all of them consider bankruptcy to be a last resort.

That's quite right too. It is right that we try to repay our debts as best as we can. To that end, I wrote an article that shows you your other solutions: Five top ways to clear your debt.

However, if we try everything and we're still unable to pay our debts, and we're killing ourselves slowly with stress and worry, and in the process making ourselves less useful to friends, family and society, then we should consider bankruptcy. It's an option that we have in law to protect all of us from the consequences of severe distress and some of us from irresponsible lending by the banks and other financial institutions, which are supposed to be the professionals that know better.

It costs money to go bankrupt

It's been possible to go bankrupt in Scotland very cheaply for some time (currently £100). In England, Wales and Northern Ireland debtors must pay a more difficult £345 to £495. The costs usually go up in April. This year it'll go up by £15.

If you can't pay your bills

If you can't pay your debts then you're 'insolvent'. You become bankrupt when you are insolvent, but bankruptcy isn't the only formal option available to insolvent people. An alternative is an IVA in England, Wales and Northern Ireland, and a trust deed in Scotland, but these are not only more costly than bankruptcy, they're also unsuitable for the majority of insolvent people. (Think carefully before you buy one of these plans, and read about your alternatives.)

From 6 April 2009, many of the poorer debtors will have another, cheaper way to go insolvent. This is called a Debt Relief Order (DRO), and it'll affect about 11% of people who become formally insolvent (according to the Institute of Money Advisers).

Debt Relief Orders

As with bankruptcy and IVAs, you must be insolvent - unable to pay your debts - in order to qualify for a DRO. It'll cost just £90. The other criteria are that:

• Your total debts are £15,000 or less.
• You're not a homeowner.
• Your total assets are £300 or less. This figure excludes typical household goods, provided they're not extraordinarily expensive, and a vehicle worth £1,000 or less.
• Your income after typical bills and expenses is £50 per month or less.

As you can see, this is aimed at the poorest and most vulnerable people. It's basically a cheap bankruptcy and works almost the same way. Creditors must stop harassing you, you're usually free from your debts within 12 months of the order, and you still need to make additional payments to your creditors if your financial circumstances improve within that time. You'll still have to work with an administrator, the Official Receiver, but you won't have to appear in court before a judge.

Will more people abuse the system?

I doubt that this cheaper bankruptcy will make many more people go fraudulently bankrupt. Anyone who runs up debts with the intention of getting a DRO could do the same with an old-fashioned bankruptcy order. You can get a DRO just once every six years and you can't get it if you're already going through a formal insolvency procedure, so it's hardly a regular money spinner for the abusing minority.

What's more, the Official Receiver retains strong powers to investigate finances for dodgy behaviour (e.g. huge borrowings that were used to fund a big pension contribution in order to protect -and steal - the money from creditors).

In addition, a DRO won't be any gentler on debtors who have simply made mistakes. The DRO bankruptcy is still listed publicly. It still goes on the credit record for six years and will be at least as damaging as a bankruptcy order.

What's more, you can only get one of these when you've consulted an approved middleman. This could be a debt-management company or even Citizens' Advice. You can't apply for the DRO direct: the middleman must decide it's the best debt solution for you and then it will make the DRO application on your behalf (for free).

Furthermore, DROs won't tie up judges' time with simple cases and it'll take less of the Official Receivers' time, so I expect overall this should put our legal system to better use.

A tip for debtors

Debtors should be careful when getting advice on debt as many debt advisers (the middlemen in this case) will either be profit-making or have ties with lenders. This might affect their advice. As they are not allowed to charge money for a DRO, they may suggest a less appropriate solution for you. Always get a second opinion on your debt solution. I recommend two resources with fantastic feedback: National Debtline and The Motley Fool's Dealing with Debt discussion board.

> Further reading: Eight dealing with debt tips and Improve your credit score.