Dealing with debt, how it actually works…

Currently you could say the world is divided into the ‘haves’ the ‘have nots’ and the ‘have not paid for what they haves’. Today I’ll explain how to deal with debt when you run into problems, to do this I interviewed a few trusted sources who work as actual collectors. This is such a huge topic that I’ll break it down into two halves, this week we look at the early stages of arrears.

Getting into financial trouble doesn’t always come with a bang, often you drift into it over time due to paycuts, higher taxes and spent savings. This is our first area, it’s called ‘pre-arrears’ and it gets very little little attention.

The Code of Conduct on Mortgage Arrears (CCMA) requires that a banks mortgage arrears resolution process applies to those in arrears and those who may go into arrears. All it takes for you to be classified in this category is for you to tell your bank that you are having difficulty.

All banks take the view that prevention is better than cure so even if your accounts isn’t covered by the CCMA – be it a buy to let property, a credit card or term loan, your lender will want to work with you to prevent your accounts falling into arrears.

This is the stage where you should attempt to come to an arrangement which will make your repayments more affordable. Do not make the mistake of falling into arrears on purpose in the hopes of convincing your lender to reduce your payments.

You will be required to complete a financial statement (SFS) and provide supporting documentation, if your assessor sees that you were able to make all or most the last few payments and you have paid nothing, they will not be willing to come to an arrangement.

You’ll also have arrears you may not be in a position to clear and your credit rating with the ICB may have been affected when the bank may have been quite willing to restructure your loan before the arrears arose.

Some lenders may agree a short term temp arrangement (1 or 2 months) of a reduced payment to allow you time to gather your information. All lenders may not do this but always ask. Never be afraid to ask for something you don’t think you will get.

The next stage is when you have missed a full payment, if your account is less than 1 month in arrears you might get an automatic letter and possibly a phonecall from an ‘early’ arrears team. Again this is part of the prevention tactic of the bank.

When you owe less than 1 month it will not register as a missed payment on the ICB. For this reason you may decide that another bill has more priority despite the collector trying to convince you that you should prioritise your debt (after all they are working on targets). You could then clear the small arrears at a later stage.

You should only make this decision if you are sure that there is not an ongoing problem and you are are sure you can maintain full payments on the mortgage going forward. Be aware that your arrears are being charged interest so it is best to clear as soon as you can.

If you go beyond one month it changes, when the arrears get into the 2-3 months banks would make a concerted effort to prevent the arrears increasing. The reasons for this are not simply because bankers are nice people who want to help you.

Your lender has a requirement to maintain certain levels of capital to cover losses the bank may make. Banks have to constantly monitor their risk and they will have calculated the probability of default of each loan book.

When your account is not in arrears or is in early arrears the bank will have calculated the probability of default of its loan book based on internal or external data. When your specific loan is in arrears of 4 months the account is now officially in default. This means the probability of default is now 100% which means the bank will have to increase its provisions to cover this increased credit risk.

The more loans that are in default the more capital the bank has to put aside to mitigate the risk of a loss being realised. This means that the bank will do whatever it can to stop your account falling more than 3 months due. You should use this to your advantage when you have reached that level of arrears.

You can make a proposal for reduced payments on the basis that you will pay X amount off the arrears each month to bring the arrears away from this danger zone for the bank. While the collector you are dealing with may not be aware of this level of portfolio management you can be sure that when your proposal is passed up the line for approval.

It will be assessed by someone with the knowledge of the benefit to the bank in agreeing to any arrangement that brings the arrears back out of the default zone. That is the early stages covered, the important point is to remember to engage and communicate with your lender, that will buy you time, next week we’ll look at the scary step-sister known as ‘deep arrears’ and show you how to navigate those more frightening waters.

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