Keep tackling the debt or file for bankruptcy?
Debt Consolidation, Consumer Proposal or Bankruptcy. What should you choose?
When it’s difficult to get ahead and when you are constantly feeling the pressure of debt, bankruptcy might be a viable option. However, it should not be the first option you jump to without first considering other alternatives. Filing for bankruptcy can have significant long-term implications on your credit score and overall financial goals. So make sure you fully understand what you are getting into before proceeding. Let’s explore some options to consider before bankruptcy and then look into what long term factors you should consider if you do decide that bankruptcy is the best route.
Note: The information noted below is based on the Bankruptcy and Insolvency Act in Canada. If you are outside of Canada, please refer to the applicable laws in your country.
If you would like to speak to someone in our network regarding consumer proposals and bankruptcy, please send an email to hello@mintworthy.co and we will put you in contact with our preferred debt solutions partners.
Debt Consolidation
Debt consolidation is the first step to consider when you are looking to get out of debt faster.
Debt consolidation involves bringing together (“consolidating”) all of your debts into one large debt. You basically ask a creditor to loan you one big lump sum of money to pay off all your individual debts. For instance, instead of having 3 credit cards plus a line of credit, you would have one loan for the total amount and would pay one monthly payment. Often times, consolidation loans are at a lower interest rate, saving you thousands on interest fees and allowing you to pay off your debt faster. Your debt payments become more manageable and you only have one debt to focus on.
Factors to consider:
You will still have to repay the full amount of your debt. Your debt will not be reduced, it will just be paid together at a lower interest rate.
You will need to be disciplined and ready to shift your habits and behaviours around debt. Consolidating will pay off all of your credit cards, so you will need to ensure you are not tempted to use them. Call and ask for a credit limit decrease or keep the cards at home or in a place that is hard to get to.
One form of consolidation is to re-mortgage your property and roll your consumer debts (ie. credit cards, line of credit, etc.) into the mortgage. Your mortgage payment will increase and if you can not make this payment you run the risk of losing your home.
There has been a significant decrease in unsecured consolidation loans being issued by financial institutions, so if you don’t have any collateral (ie. property, significant investments), it may be difficult to quality for this type of loan.
If you are unable to qualify for a consolidation loan, a consumer proposal might be your next option.
Consumer Proposal
A Consumer Proposal allows you to legally repay only a portion of your total debts. The proposal is filed through a Licensed Insolvency Trustee and presented to your creditors. If your creditors accept the proposal, a portion of your debt is forgiven (eliminated) and you agree to pay the remaining portion. In most cases, consumer proposals can eliminate 50 – 80% of your total debt.
A payment plan is determined where you pay a set amount monthly. The amount is repaid interest-free over the term of the proposal. The monthly amount will depend on various factors including your total debt, employment status, monthly expenses, your assets and the proposal period. The proposal can also be paid off sooner with no penalties. A proposal is a great option to get out of debt without the impact of bankruptcy.
Factors to consider:
A consumer proposal will impact your credit rating and is reported on your credit report. It will remain on your credit report for 3 years after the date the proposal is paid in full. For instance, if your proposal payment plan is for 2 years, the proposal will remain on your credit report for a total of 5 years. If your payment plan is for 5 years, it will remain on your report for 8 years.
With the proposal on your credit report it will be difficult to obtain large credit such as a mortgage. This does not mean you can never obtain a mortgage; you may just have to adjust your financial goals to purchase the home a few years later.
Although there will be a negative impact on your credit score, your monthly debt payments will decrease which will free up your monthly cash flow. This will allow you to have more money for your living expenses and savings (for short term/building an emergency fund, a home downpayment, retirement, etc.).
You will have to pay legal and administrative fees. These fees are rolled into your monthly proposal payments and will be based on the portion of debt you have to repay.
You will be able to obtain new credit (ie. a credit card) while in your proposal which will allow you to start repairing and rebuilding your credit score. The amount of credit you are approved for will be significantly smaller than what you obtained prior to your proposal.
Bankruptcy
When there are no other options and debts are extremely difficult to manage, filing for bankruptcy can be a solution. Although bankruptcy can eliminate your unsecured debts, there are significant impacts to your credit score and future financial goals.
A bankruptcy remains on your credit report for 7 years. When in bankruptcy you can not obtain any form of credit. This means you will not be able to obtain any credit cards, loans or a mortgage. This must be heavily considered as it will impact the timing of your future financial goals. Due to this, you will not be able to start rebuilding your credit score until you are discharged or out of bankruptcy.
In addition, when you file for bankruptcy there are some administrative tasks that you may be required to fulfill. For instance, you are required to:
Submit monthly income and expense reports during the time of your bankruptcy
Attend counseling sessions
Factors to consider:
You can not select which debts you wish to include in the bankruptcy.
You can not include secured debts within a bankruptcy (ie. mortgage, car loan, etc.). If you are unable to pay these loans the creditor has full ability to take possession of the asset.
You will not be excused from making support or alimony payments while under bankruptcy.
You can not include student loans which are less than 7 years.
There is no one-size-fits-all when it comes to which debt solution is best. There are many factors to consider including your specific financial goals and needs. Be sure to speak with a licensed professional to understand all of your options.