Legal consequences of debt

Resolving debt

Debt is a financial obligation to repay money owed. A creditor is the lending party and a debtor is the party who owes money to the lending party. If you have borrowed money from a vendor, such as you might apply for car finance with a car dealer, then the vendor is the lending party. If you have borrowed money from a third party, such as a bank, to pay the vendor then the bank is the lending party.

When you borrow money, you enter into a legal agreement where you have certain rights and obligations. Your main obligation is to repay the amount you borrowed, plus a set rate of interest over a specific amount of time. If you default (cannot make repayments) or are in arrears (behind on your repayments) with regard to your loan, there are a number of things you can do to try to resolve the debt.

The first step of any debt resolution is communication with the lending party. Inform your creditors of your situation as soon as you know that you are in financial trouble so that they have time to consider a solution. At this stage, depending on the reasons for your financial problems, they may even agree to refinance your loan, which involves renegotiating the conditions of the contract and may include suspending your obligations until you are able to recommence repaying the installments.

If you have a number of debts that you cannot meet, you may be eligible to apply for debt consolidation, which is a process of combining your debts into one loan. This would mean that everything you owe would attract one interest rate and you would only need to meet one repayment commitment. Creditors would prefer a debtor requesting debt consolidation to a debtor defaulting on their repayments.

Another way you could resolve your debt is to sell the item or surrender the item to the creditor as repayment, but it would mean that you lose the item that you purchased. It may be the easiest option if you are in great financial difficulty.

Legal resolutions

Creditors also have a number of rights and obligations in a loan agreement, including a right to recover any money they lend. Creditors must follow a legal process to recover money owed, but cannot intimidate or harass a debtor during this procedure. Legally, creditors must initiate a debt recovery process by serving a default notice. The default notice outlines the debtor's failure to adhere to the terms and conditions of the loan and gives the debtor 30 days to resolve the debt. If a debtor has not previously given notice of their financial difficulty, then at this stage they can request any of the resolutions already mentioned in this chapter.

After receiving a default notice there are a number of legal avenues a debtor can pursue if the creditor does not agree to the resolutions offered, including an application for hardship variation. A hardship variation (section 66 of the Consumer Credit Code 1996) involves forcing a creditor to make changes to the conditions in the loan agreement, either reducing the installment amount or postponing repayments for a specified period. These options involve extending the term of the loan, which means a debtor will eventually repay the loan when they are able.

Hardship variation is a temporary solution and debtors must prove to the creditor that they have 'reasonable cause', such as illness or unemployment, to pursue this method and that they intend to resolve the debt within a reasonable period. Debtors cannot pursue this option if the loan amount is above the variable threshold as set by the Uniform Consumer Credit Code (www.creditcode.gov.au) or if the creditor has already commenced formal legal proceedings, such as by lodging a statement of claim.

If your loan agreement involved a mortgage, that is, the use of an asset as security, then the creditor has a stake in the asset, therefore may apply to have the asset repossessed. Repossession is the reclamation of an asset for the purposes of recovering a debt. A creditor must make a Statement of Claim for Repossession, giving the debtor 30 days to resolve the debt.

Creditors cannot initiate repossession if the debtor has 25% or less to repay on the principal. They cannot access the asset if the asset resides on private property unless they have a court order to enter the property. They must then notify the debtor of the goods' value, any additional expenses with regard to the act of repossession and their rights in relation to recovering the repossessed item. A debtor can apply to postpone repossession (section 86 of the Consumer Credit Code 1996) if they believe that they will soon be able to meet repayments.

If you are employed and receive a regular income, creditors have the opportunity to seek a legal order to garnish your income, which involves the automatic deduction of repayments from your earnings. The court will decide if this is a fair way for the creditor to recover a debt based on your other financial commitments, for example, if you are a low income earner with dependants, then garnishment may not be the most suitable way to resolve the debt.

Bankruptcy is a form of legal protection that financially shields a debtor from actions by a creditor. Debtors can opt to resolve their financial difficulty in this manner or creditors may force bankruptcy on a debtor to prevent financial operation.

Bankruptcy means that the debtor does not need to meet their repayment obligations, but this status also prevents them from borrowing money, usually for three years. It also remains on record with a credit-reporting agency, such as Baycorp (mainland Australia) or the Tasmanian Collection Service, for seven years, which limits future applications for credit. During the time of bankruptcy, the bankrupt cannot serve as director of a company. Courts will also monitor their income, restricting a bankrupt's standard of living. The stigma from bankruptcy may affect business credibility for the bankrupt's future ventures.

Any action taken against a debtor in this context will add to information on their credit file, which will in turn affect their credit rating when a lending party assesses their application for credit in the future.