If an individual is unable to service their debt, then they are approaching personal insolvency. In this instance, a debt consolidation loan is neither appropriate nor feasible.
If an individual cannot meet their existing repayments, it may not be possible for them to pay off the consolidation loan, even if this loan is spread over a longer period, or charges a lower rate of interest.
Often, debt consolidation is used as a form of debt management, i.e. it helps the debtor manage and organize their money / debt more effectively. A common sales line offered by companies marketing debt consolidation loans is that they (the debtor) will have a single, easy to manage monthly payment.
For those that are beyond the point of being able to service a debt consolidation loan, then, personal insolvency may be the only option left open to them. Personal insolvency can be a painful and difficult process. Personal insolvency, or bankruptcy also has a stigma attached to it which deters many from applying at an earlier stage.
When an individual declares bankruptcy, all assets are put under the control of a magistrate, who then, along with a panel decides how best to use these assets in order to pay off creditors. This means all the individuals assets, their home, their car, any capitol they have are all taken away from the applicant. As a bankrupt, all control over assets is relinquished.
Declaring bankruptcy has longer lasting implications also, for example future credit / mortgages will be difficult to obtain, and, a bankrupt cannot become the director of a company for a given period of time. In return for handing over all assets, the debtor has the remaining portion of their debt (the part they cannot afford to pay) written off.
An alternative to bankruptcy is an IVA (Individual Voluntary Arrangement). With an IVA the applicant retains control of many of their assets, most importantly their home. In an IVA, creditors agree to write off the portion of the debt that the applicant cannot afford to pay. If 75% of the creditors (those holding 75% of the debt) agree to the drafting of an IVA, then, the process may continue, if not, the debtor must revert to debt management, or bankruptcy.
Once the IVA is agreed, both parties are legally bound (UK Only) to the agreement. That is to say, the creditor cannot subsequently seek compensation / further repayment of debts it has agreed to write off. The creditor on the other hand must agree to pay the agreed amount on time every month. After an agreed period (typically 3 to 5 years) the remaining portion of the debt is written off, and, the debtor is considered “debt free”.
The advantage of an IVA for the debtor is that they are able to protect their assets, i.e. their home. The advantage for the creditor is that they are often able to recoup more of the debt than they would be able to if the debtor were to declare bankruptcy, or, simply fail to pay.
IVA’s are of course only suitable for those with high levels of unsecured debt, where their home cannot be repossessed by the creditor.