Debt is a pretty common thing to have. Just about everyone experiences debt at some point, whether it’s taking out a student loan, signing their first mortgage, buying a car with an auto loan, or using a credit card.
However, it quickly becomes a problem when you lose income, or your debts grow to the point that you miss payments or consistently only make minimum payments. When money is tight, a small minimum payment (a small percentage of what you owe) can seem like a lifeline, but it’s actually a trap designed to maximize the cost of debt through interest charges. The longer you hold onto a debt, the more you wind up paying the credit card company.
Fortunately, debt is not a life sentence and there are ways to get out. The least invasive way out of debt is generally the best. If you have resources for paying back creditors, it’s best to use them. These might include:
- Using savings (though keep in mind, most RRSP savings are exempt from bankruptcy proceedings),
- Selling assets (see which assets are exempt from bankruptcy);
- Renting out part of your home;
- Cutting costs by selling your car or cutting back elsewhere.
A good rule of thumb to go by is that if you can pay unsecured debts off over 24 months, it’s reasonable to pay it all back yourself. However, if it’s not feasible and you don’t have the resources to pay it all back on your own, there are still options. You can get debt relief today with these three options.
#1 Debt Management Plan
A debt management plan is voluntary for each of your unsecured creditors. In a DMP, a credit counselling agency (usually a non-profit) will approach your creditors and ask them to consolidate your debts. The idea is to bundle your payments together into something affordable for you and provide relief from interest charges by lowering or eliminating them altogether. Participation is voluntary for creditors, though they may prefer a DMP over a consumer proposal or bankruptcy in order to recoup all of their principal.
You will still have to pay all of the principal, but relief from interest goes a long way. Interest charges can leave you spending multiple times more than what you initially borrowed. The problem is that interest charges are paid off first, not principal. For example, if you owed $2,000 on a credit card with 20% interest and made monthly minimum payments of $10 (against the principal) plus interest charges, you would wind up paying a total of $5,300 over the course of 200 months.
The credit counselling agencies who arrange debt management plans charge a fee based on what you can afford and may receive donations from creditors as well.
#2 Consumer Proposal
In a consumer proposal, you work with a Licensed Insolvency Trustee to propose a fixed monthly payment to your creditors. The Licensed Insolvency Trustee assesses your finances, including your income, assets, and expenses to find a number that you can afford that’s still fair to your creditors. This is a great solution for people who are insolvent but making a steady income, as it preserves all of your assets and savings. Once your creditors have agreed to a consumer proposal, your monthly payment does not change, even if your income increases.
There are a few factors that make a consumer proposal an attractive option out of debt:
- The principal you have to pay back is reduced. This kind of debt relief can be essential when you cannot afford to repay everything.
- There are no interest charges. Even though you can take up to five years to complete your consumer proposal, you only repay the principal.
- It is legally binding. If the majority of your unsecured creditors agree to the proposal, they are all bound by its terms. In this case, a majority is considered to be voting creditors who are owed 50% of your total debts plus one dollar. While some creditors may chose not to vote on the proposal, all creditors are still bound by the proposal terms if it is accepted, even the CRA (for more information on making sense of tax debt, see our earlier blog post).
- You can take up to five years to pay a consumer proposal, but if you find yourself with more money to repay debts, you can complete it sooner.
There are downsides to a consumer proposal as well. It will significantly impact your credit rating, as all accounts covered by the proposal will be hit with a low R7 rating on your credit report. The only lower ratings are an R8 (repossession) and R9 (bankruptcy). This will make it harder (but not impossible) to qualify for any future loans or credit cards.
A consumer proposal is filed by a Licensed Insolvency Trustee. These are federally regulated professionals who receive a portion of the total funds distributed to your creditors.
Bankruptcy is often seen as the last option, but there are times when bankruptcy makes sense. When there is no other way to pay your debts, you’ve had a consumer proposal rejected, or in cases where you don’t have many assets, filing for bankruptcy is a way forward.
In a bankruptcy, your debts are discharged, but at the cost of liquidating certain assets. There are exempt assets, including some equity in your home and car, as well as household goods, work-related tools, and most RRSP savings (except those made within 12 months of filing for bankruptcy).
If you want to see how these three options compare, check out this debt repayment calculator. It can give you an estimate of how much you should expect to pay in total based on how much unsecured debt you have with each method, based on averages. The numbers will change depending on the interest rates you pay, but it gives you a sense of how each option compares.
There are many ways out of debt. Do your research and find the one that makes the most sense for you. You can also book a consultation with a Licensed Insolvency Trustee in Victoria, Nanaimo, and across Vancouver Island to learn more.