Despite what you may have heard, there are a lot more proven and legal ways to reduce large amounts of debt than simply filing bankruptcy.
In fact, our analysis of over 3000 Canadian families struggling with high levels of household debt (average of $51, 394 household debt with 9 creditors) shows that while many Canadians first turn to bankruptcy as a way out of debt, the majority end up choosing other methods such as consumer proposals and consolidation loans.
Today, I’m going to walk you through the most popular methods in Canada for dealing with large and unmanageable sums of debt (typically 10K and above).
Each year, thousands of Canadians use these tactics to get out of debt and I’ll show the pros and cons of each method.
#1 – Debt Consolidation
When businesses get into trouble, they will typically work to consolidate or restructure their debt. This option is also available to Canadian consumers and is a popular way to deal with large amounts of unsecured debt.
In simple English, debt consolidation involves taking out one big loan to pay off many small loans.
The biggest benefit is that you will save thousands of dollars in interest. You are essentially grouping all your individual debts into one big sum. So, this replaces the high-interest credit card debt with a lower interest consolidation loan and you’ll end up paying much less interest (which is a huge deal on, for example, 30K in debt).
The drawbacks of this technique is that technically you are simply replacing your debt with another debt. Lots of personal finance blogs and hardcore frugal savers don’t like this idea as you are taking out a loan to pay off smaller loans.
But, small loans typically have high interest. For example, if you buy a $3,000 TV from a major retailer on credit, they will charge you a very high-interest rate. But if you take out a $25,000 student loan, you will get a better interest rate.
So debt consolidation is really about leveraging your creditworthiness with the primary goal of lowering your interest rate.
When to use it: you hold average amounts of unsecured debt (between of 10-25K) and the new consolidated payment easily fits within your budget
Impact on credit: zero impact
Best benefit: you’ll save thousands in interest and have one payment each month
Biggest drawback: if your debt is unmanageable this will not be a sustainable solution
If you want to learn more about debt consolidation, we’ve written a comprehensive guide that will answer all your questions.
#2 – Consumer Proposal
When Canadians get into serious debt, they often think that they will end up filing bankruptcy. Yet, bankruptcy is usually only recommended for extreme situations. As a result, a high percentage of people who begin the bankruptcy process typically end up filing a consumer proposal.
A consumer proposal is essentially an offer you make to all of your unsecured creditors. You agree to a single, fixed monthly payment and a new amount to repay.
Now, consumers in Canada typically hear that consumer proposals can impact your credit rating. This is true but consumer proposals are very effective and completely legal ways to deal with large amounts of debt. They are a legally binding agreement and approved by the courts.
The biggest benefit is that you will usually be reducing the overall amount of debt you owe. For example, creditors will realize you are in financial trouble and if you file bankruptcy, then everyone loses. So, a consumer proposal works out a deal, often with creditors agreeing a large reduction in the debt owed.
When you file a consumer proposal, you will have protection from your creditors taking any action to collect the debt, you will typically pay a greatly reduced amount with zero interest. We’ve seen consumers have their debt reduced by huge amounts such as 80% reductions from the original sum.
This year, we analyzed over 3000 Canadian families that we helped deal with large amounts of debt. Our research showed that consumer proposals were typically the most popular way to deal with debt for families we help.
When to use it: large amounts of unsecured debt (upwards of 10K)
Impact on credit: less severe than bankruptcy but remains on the credit report as R7 for three years after proposal is completed
Best benefit: you’ll save thousands by asking creditors to reduce the principal amount owing
Biggest drawback: impact on credit rating
Canadians tend to have lots of questions about consumer proposals especially the impact they have on credit ratings and the difference between consumer proposals and debt consolidation. We’ve written a comprehensive guide here.
#3 – Informal Proposal
With a consumer proposal, it is filed under the bankruptcy and insolvency act and requires a bankruptcy trustee (read this resource for full details of the role everyone plays in the debt industry) Consumer proposals are legal offers made to creditors and require your creditors to accept the new terms of the debt payment.
An informal proposal is similar to a consumer proposal in the fact you are agreeing a reduced settlement with your creditors.
The big difference is that it is not filed under the bankruptcy and insolvency act and each creditor is dealt with individually versus an offer to all your creditors. This means the time to settle and the response of creditors can vary greatly.
The biggest benefit of an informal proposal is the flexibility it offers if your situation does not make a consumer proposal viable.
You can do it yourself but but you are dealing with very experienced industry professionals and the results could be dramatically different based on each creditor and could result in extra penalties, no legal protection if the creditor changes course, and uncooperative creditors and collection agencies.
When to use it: when a consumer proposal is not an option or you have small debt loads in default (less than 10K range)
Impact on credit: can sometimes be negotiated but usually same as consumer proposal (R7 rating for three years after debts paid)
Best benefit: you can save thousands by asking creditors to reduce the principal amount owing and can clear up bad debts to start rebuilding your credit
Biggest drawback: impact on credit rating and uncertainty of settlements
#4 – Work with Your Mortgage Lender
If you run into mortgage payment problems, it’s important to be proactive. Your bank doesn’t want you to lose your home. One of the debt tactics that many Canadians ignore is working with their lender and finding a solution.
The Canada Mortgage and Housing Corporation (CMHC) suggests contact your mortgage lender right away when you run into mortgage problems. You can then work with your lender to find a solution.
Possible solutions they might offer:
- Offering a temporary short-term payment deferral. You might be allowed greater payment flexibilities, especially if previous lump sum payments have been made or if you have shown good faith with an accelerated payment schedule.
- Extend the original repayment period (amortization) in order to lower your monthly mortgage payments. When things get better, you can negotiate again.
- Adding any missed payments (arrears) to the mortgage balance and spreading them over the remaining mortgage repayment period.
- Offering a special payment arrangement unique to your particular financial situation.
We’ve written a resource for families and individuals having trouble making their mortgage payments here.
#5 – Focus and Manage Cash Flow
We work with thousands of Canadians in every province struggling with debt. In our experience, it’s often a very minor expense that tips the scales and turns debt problems into a dire financial situation.
The Canadian families, individuals, and businesses we help are not irresponsible or unemployed. Most are hard-working families with good incomes such as teachers, plumbers, bus drivers, and public servants.
By creating a solid debt repayment strategy you can really protect yourself. One of the common mistakes we see is that families sacrifice their long term financial goals due to high monthly debt repayments.
They are typically pouring every dollar into debt servicing debt often to only meet the minimum monthly payments with little reduction in the principal owed, leaving little breathing room for unexpected expenses.
The two key areas that are often missed when creating a plan to manage debt are the pre-work analyzing cash flow and the post-work implementing a comprehensive credit rebuilding plan and using any additional cash flow to meet your long-term financial goals.
These are ultimately the cornerstone of the debt restructuring plan and can be the difference between success and failure. I don’t mean this as a product pitch, but 97% of people entering into a debt restructuring plan with 4 Pillars successfully complete the program and we believe this is the highest in the industry.
We credit this success to making debt repayment “livable.” You have to look out for your overall financial situation.
You can’t just dump every penny into debt payments as this leaves you vulnerable and tends to lead to more borrowing, refinancing, and using backup credit as soon as it is available again.
#6 – Sell Assets and Downsize
This is one of the hardest and drastic ways to get out of large sums of debt. It’s hard to sell a condo or fancy car and downgrading your life is never easy.
Most people look to will sell critical assets to avoid bankruptcy. However, it can result in you paying back some of your debts in full and leaving others you still struggle to pay and can have a negative impact on long term cash flow and wealth creation.
If you owe a large sum, it’s best to consider consumer proposals and debt consolidation before you sell your home or a large asset.
The biggest benefit to selling an asset, though, is that you’ll have a lump sum of cash that you use as leverage while negotiating with creditors.
This may earn you a better rate as you pay down the principal and lower your debt service ratio and may make a consolidation loan a viable option that could save you thousands of dollars in interest in the long run.
The drawback, of course, is that you will often sell the asset at below market value and sometimes at a loss.
Think carefully about selling assets quickly, especially if this only means a temporary fix to your debt. So while this one of the most common options it can be dangerous.
Selling your assets might help in the short-term but could cripple you in the future.
When to use it: when you can downsize or liquidate luxury items that are not essential and you are able to significantly increase cash flow and reduce debt
Impact on credit: little to none if debts are paid in full
Best benefit: if the asset is large enough, it could pay off the debt in full
Biggest drawback: you’ll pay 100% of your debt back and potentially lose thousands on the sale of the asset
#7 – Build a Debt Restructuring Plan
Debt restructuring plans have similarities to consolidation loans. But the essential difference is that while a consolidation loan might attack a particular section of debt (such as a Future Shop line of credit, a car loan, and credit card debt), a debt restructuring plan looks at the bigger picture.
A debt restructuring plan usually involves an analysis of your cash flow, debts, assets and immediate needs (such as upcoming car repairs or mortgage payment difficulties) and then formulates a comprehensive plan for the future.
The biggest benefit is that you’ll be using a combination of tactics including debt restructuring , budget plan, and an eventual plan to rebuild your credit.
The drawback is that there typically will be an impact to your credit. However, as many financial blogs point out, worrying obsessively about your credit rating when in huge amounts of debt isn’t the most logical approach. Credit can be rebuilt and no lender is going to offer you a good mortgage if you have 50K in unsecured debt that you are struggling to pay.
When to use it: large amounts of unsecured debt with missed payments and general trouble keeping up with debt
Impact on credit: the impact can be as little as 3 years but all 4 Pillars plans include tactics to rebuild your credit
Best benefit: you can drastically reduce your debt loads and be able to keep your assets and better rebuild your finances and move from financial meltdown to wealth creation
Biggest drawback: you will have a temporary impact to your credit
How does this practically work? This case study outlines a typical debt restructuring plan.
#8 – File Bankruptcy
When Canadians fall into debt, bankruptcy is the first option they think of. Yet, it’s actually one of the most drastic and undesirable ways to deal with debt.
The benefits of bankruptcy are obvious. You get to start fresh and clear your debts.
Yet, it’s much harder to complete a bankruptcy than you might think and if given the choice many Canadians who apply for bankruptcy actually end up filing a consumer proposal.
Aside from potentially losing your home and assets, there is a constant monitoring of income and the greater your income the higher your bankruptcy payment and the longer you can be kept in bankruptcy, it also has the most severe impact on your credit rating and is reported as R9’s on your credit rating for 6 years after you are discharged from Bankruptcy.
If you have to file bankruptcy a second time, the bankruptcy will remain on your credit rating for 14 years.
When to use it: last resort after all other options listed above have been considered
Impact on credit: most severe R9 rating for 6 years after you are discharged
Best benefit: you’ll eliminate most debts and receive protection from your creditors
Biggest drawback: severe impact to credit, you may lose major assets and your income and assets are monitored during the bankruptcy
If you have questions about whether your spouse will be affected, what assets you lose in bankruptcy, and other common questions, this resource will explain the basics of filing bankruptcy.
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