Debt options in Canada: Know the sharks, beat the game

 

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This post is written by 4 Pillars’ managing partner and financial literacy expert Paul Murphy. Paul has 20+ years of experience in the banking and financial service industry. 

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This is an excerpt from my book Beating the Debt Game. You can get a free copy of my book here.

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If you visit a doctor or lawyer, they have a legal duty to act in your best interests. This does not exist in the financial advisory industry.

When receiving financial advice from your bank or investment advisor and there is a range of products and debt options that they can sell you, they will usually sell the one that makes them a greater commission or brings them closer to meeting their monthly sales targets. This regularly includes credit facilities we don’t need that push us further into debt and further away from achieving our financial dreams.

To protect yourself, you need to learn how the system works so that it works for you, not against you. Starting with this one very simple philosophy that overrides everything else: if you are in the debt advisory business, you either represent the debtor or the creditor.

It is impossible to do both.

When the average Canadian gets into trouble, they think of bankruptcy. This is by far the most well-known debt option throughout the world.

You’ve heard of bankruptcy. But if you’re like most Canadians,
you don’t fully understand the extent of what it means. Even worse, thousands of Canadians unnecessarily declare bankruptcy every year, losing their assets. And worst of all, they didn’t even know there were other—much better and less costly—ways to fix their debt crisis.

Meet the players in the debt game

Here are all the different players in the debt game. When evaluating debt options, it’s best to talk to many people, get second opinions, and educate yourself along the way.

Non-Profit Credit Counsellors
Credit counsellors are a well-publicized option. You’ve probably seen their ads on busses and billboards as many of the non-profit credit counsellors have big advertising budgets.

Using a credit counsellor will have a major negative impact on your credit rating. The impact is usually for eight years at an R7 (debts paid as part of a new agreement). It will generally take five years to pay off the program and three years after that.

What most Canadians do not know is that most non-profit credit counsellors receive funding from the major creditors, which means the big banks. This is why they can advertise so prolifically. As they are funded by the creditors, how can they be only representing the needs of the debtor? They would seem to have an obvious conflict of interest.

With a credit counsellor, you will usually pay back 100% of what you owe, plus fees. In this way, it’s like a consolidation loan but with a significant negative impact on your credit rating.

As it’s not filed under the Bankruptcy and Insolvency Act, they will advertise this as a better option than a consumer proposal with the rationale that there will be no public record of you entering into the program.

However, the impact on your credit is the same. In many cases, it has an even more damaging impact on your credit rating than a consumer proposal. And with a traditional consumer proposal, you’ll typically have a lower repayment amount and lower monthly payment.

While many Canadians reach out to credit counsellors, keep in mind that while the counselling itself is free, someone is paying!
If you choose to go down this route, make sure you work with an accredited non-profit credit counsellor.

In the right circumstances, a credit counsellor can be a good option. But remember that this option won’t reduce your debt and it will negatively impact your credit rating. Before you do this, fully investigate all the other options.

Informal Settlement
If you have available cash, then agreeing to a one-time settlement with each creditor can be a good debt option. However, reaching an informal settlement can be challenging and requires patience and perseverance.

You can also request new payment terms and lower interest rates. If you have already missed some payments it is highly unlikely that they will lower the interest rates, but they may agree to new repayment terms.

At the end of the day, the creditors want to get paid and they don’t want you to file a bankruptcy or a consumer proposal as they will usually get a lot less than you owe.

When you go to them, approach them with a specific plan. For the creditors to agree, you need to show them your budget as well as any other debts you have that need repaying. Be prepared to tell them the story of how you got into difficulty and the steps you have taken to overcome the challenges.

Remember, this is your chance to get a repayment plan based upon your ability to pay or to ask the creditors to accept a lump sum one-time payout for less than you owe.

Approach it professionally by submitting a written offer with the following information:

• Details around financial hardship such as reduced hours and income, illness, inability to work, business failure, divorce or separation.
• The settlement offer you are proposing, stating that if it is a one-time offer that it is the full and final settlement of the debt.
• Outline your payment in formal terms. Such as “a payment of $10,000 will be provided as a full and final settlement against my account, #487459. This will be paid as a one-time payment on
  or before month/day/year. This payment will be released based on written confirmation of the settlement before payment and a release letter to be provided by the creditor upon receipt of funds.”
• If you propose a monthly payment plan, state the frequency of the payment, the date the payment will be made, and the method such as direct payment. Also, show the creditor when the debt will be fully repaid.

Make sure that no matter what the offer is to the creditors, you can stick to the terms of the agreement. If they accept it and you don’t make the agreed payments, they will lose confidence and it will be very difficult to agree on another repayment plan.

Consumer Proposals
Many Canadians get nervous about consumer proposals as they are filed under the Bankruptcy and Insolvency Act. This makes them turn to less favorable options such as credit counselling.

However, consumer proposals can be a sharp weapon to help you reduce your debt. Don’t make an emotional decision. Instead, get an expert to review the details and take a longer view of how this will put you ahead in the future.

A consumer proposal is simply a formal offer to your unsecured creditors to repay the debt on new terms. If the majority of creditors accept the proposal it becomes a new legally binding agreement on all your unsecured debts.

Although rare, occasionally the creditors don’t accept the offer. If this happens, you are in the same position that you were in before you filed the proposal and owe the full amount of the debt.

Often though, rather than fully rejecting your offer, the creditors will come back with a counteroffer, requesting a higher return instead of an outright rejection of your proposal.

At this stage, you can decide if their counter offer is feasible for you or if you want to propose another offer for them to consider.

Creditors recognize that when you file a consumer proposal, you are facing severe financial hardship. They know that if they reject the offer, you may be left with no other alternative than to declare bankruptcy. They also know that by accepting a consumer proposal, they will usually receive more than if you declare bankruptcy.

Typically, a consumer proposal can reduce the debt owed anywhere from 20-80% of what is owed and paid back interest-free over 60 months. It’s often a good deal for people in debt.

Again, don’t accept the first option. Get a few perspectives from different experts or we strongly recommend you hire your own representative to ensure you get the best possible outcome. Never settle for the first solution offered!

Filing a consumer proposal places a legal stay of proceedings on unsecured creditors. The creditors must stop all action to collect the debt. Pending, current, or future legal action is stopped and creditors can no longer call you and demand payment.

Not all debts can be included. The proposal deals with only unsecured debts. Debts for alimony or maintenance cannot be included in the proposal and must be repaid in full. Secured debts aren’t included unless you want to walk away from the asset creditors hold as security.

A licensed insolvency trustee is required to file and administer any filing under the Bankruptcy and Insolvency Act.

However, that does not mean you cannot hire your own representative, as trustees are officers of the court and have duties to protect the interests of the creditors. They will ensure your rights are not abused but they do not work for you.

A consumer proposal reflects the same as a non-profit credit counseling program on your credit rating, an R7. However, this can be removed sooner from your credit report as it reports for a maximum of six years, not eight years.

But remember, with the non-profit program you are repaying 100% of your debt vs receiving a significant reduction in the amount owed in a consumer proposal.

With the right plan, you can pay your consumer proposal off much faster, without penalty, and have it removed off of your credit rating much faster.

The debt option nobody talks about: do nothing

This may seem like a crazy option but for some, doing nothing may be a better alternative than bankruptcy. Some people are what is known as ‘creditor proof ’.

Being creditor proof usually means you have no assets that the creditors can take legal action to seize or lien and the type of income you have cannot be garnished by a creditor.

Certain types of income cannot be garnished. It may also be that the statute of limitations has passed on a creditor being able to take legal action.
Being creditor proof doesn’t mean the creditors and debt collectors will stop calling or that it won’t continue to harm your credit report. It just means that the creditor cannot take legal action to collect the debts.

If your debt is manageable and you can pay off your debt, not just pay it down, then build your plan and stick to it.

Banks, credit unions, and traditional lenders
Banks and credit unions are a good place to look for a consolidation loan. Remember, you will need a good credit score and a clean credit report, a steady job or income source to support the loan payments and a manageable debt load based on your income and expenses.

An independent expert (debt advisor)
You can also get an expert to guide you through the process.

Consider a decision like finding the right mortgage. Mortgage brokers have an insider view of the hidden fees that banks charge, know which smaller lenders will offer lower fees than the big banks, and can work from your specific situation, rather than just what the local bank offers.

Debt is no different. You can work with a third-party independent company that provides specialized knowledge to those facing financial challenges.

They will review all the options available with you including those available inside and outside the Bankruptcy and Insolvency Act (BIA) and will work with you to help find and implement the best possible situation for your needs.

When required, they will act as a go-between for you as the debtor and a trustee. These include services offered before, during, or after an insolvency filing under the BIA.

They include working with the debtor to complete a full financial review and sharing information about formal insolvency proceedings. Money management and budgeting advice, credit education and credit rebuilding are also provided.

Unlike the trustee who is technically paid by the creditors, the debt advisor works for the debtor and is paid by the debtor. The fee is usually in the form of a consulting fee and based on the range of services provided.

Fully understand what you are paying for and what services you are going to receive and make sure this is documented in their contract.

For those with excellent knowledge of the debt options available, who fully understand the insolvency process and do not require extended financial rehabilitation services, working alone can be a good option.

For those intimidated in navigating the debt industry alone and require ongoing support to rebuild credit, working with a debt advisor can remove the fear and provide you with an advocate of your own.

Licensed Insolvency Trustee

The licensed insolvency trustee (LIT) plays a complex role and is misunderstood debt option. As discussed, any filing under the bankruptcy act requires an LIT. Therefore, if you are considering a consumer proposal or bankruptcy you will need an LIT.

‘The dual role of the licensed insolvency trustee is to investigate your affairs and to ensure that your rights are not abused while protecting the rights of your creditors,” says the bankruptcy act.

What this means is that the LIT has duties to several different stakeholders. They must ensure that you, the debtor, are properly informed on all aspects relating to the bankruptcy act and they also must ensure the creditors are fairly represented.

The LIT will investigate your situation to ensure that full disclosure of your financial affairs is obtained.

They ensure everyone plays by the rules. They protect your interests if the creditors are not following the restrictions that the bankruptcy act places on them, and they ensure that the creditors are fairly represented through the process.

The role is often referred to as a ‘referee’ – there are two teams, the debtors and the creditors, and both must play by the rules set out within the BIA.

They will explain all the options available under the BIA, i.e. formal proposal and bankruptcy, and ensure you understand each option and their expectations from you for each option.

They also administer all aspects of a consumer proposal or bankruptcy. They collect the funds paid in a bankruptcy and consumer proposal and distribute those funds to the creditors.

It’s important to remember: LITs are businesses and make money from dealing with your debt. They are paid by a tariff set by the government. They often say they are technically paid by the creditors as they are paid out of the proceeds paid by you, the debtor in a consumer proposal or bankruptcy.

For example, in bankruptcy, an individual may be required to make monthly payments based on their income into their bankruptcy. The order of the disbursement of the funds paid into the estate is as follows: government fees are paid first, then LIT fees, and then the creditors.

The LIT fees in a consumer proposal are calculated as follows: the first $1,500 of receipts payable under the proposal and 20 percent of the funds collected after that.

Licensed insolvency trustees do not work for the government and are not employees of the government. They are for-profit companies that work for themselves or a local or national firm of trustees.

It is also important to note, the LIT is paid a greater fee when the debtor pays back a higher amount. This means the LIT has to balance the need for their profits and their duties to the creditors. This in my view causes many conflicts with the debtors’ priority to get the lowest possible settlement.

Remember what we said above and the one principle that overrides all others: when in the debt advisory business you either represent the creditors or the debtors and it is impossible to do both.

This in no way makes the LITs bad people, and they follow a very strict code of ethics, but it must be understood that their duties to the BIA places restrictions on them and the fee structure places them in conflict with the needs of the debtor.

Debt consolidation loans

Usually, when debt mounts up and we are struggling to manage the multiple payments, the first option we turn to is a debt consolidation loan.

Debt repayment can not only take up a significant amount of available cash every month, but it can also be difficult to manage all the payments, ensuring they are made on time so you don’t incur late fees or impact your credit rating.

Paying high interest on multiple credit cards can keep you in debt for a very long time when a large portion of the payment is going to interest instead of the principle.

One solution is to apply for a debt consolidation loan. Consolidating all your payments into one loan and paying less interest can be a great stress reliever for many. It not only increases cash flow but it also creates a future date to have the debt repaid.

However, replacing many debts with one debt doesn’t work for everyone and can create future financial problems that are greater than the ones you currently face.

For you to understand if debt consolidation is the right option, you have to understand all the options available, including what all the benefits might be.

For example, financial benefits; will this save me money on interest? Emotional benefits; will it remove the stress of having multiple payments? And finally you have to understand your personality and spending habits; do you have the discipline that this requires?

A debt consolidation loan means you get one single larger loan to pay off all of your credit cards and smaller loans. This leaves you with one monthly payment vs numerous payments all on different dates and usually lowers the monthly payment, making it more manageable. It also lowers the interest rate allowing you to pay off your debt more quickly.

There are two types: secured and unsecured.

Taking out a secured debt consolidation loan will require you to provide security against the loan. This is most commonly done by refinancing a mortgage or obtaining a line of credit secured against your home.

As the name implies, unsecured loans don’t require security and approval is based on income and credit rating. It will usually have a higher interest rate than a secured loan as no security is provided.

Which one is better?

The pros and cons of a secured debt consolidation loan

The pros
Lower interest rates – Secured loans provide the lender security if the debt isn’t repaid, although they never want to be in a position to take the asset pledged as security. As a borrower, we always make it a priority to pay the secured debt over unsecured debt as the consequences of not paying are usually greater i.e. you could lose your home.

Ultimately, lower interest rates will likely make the monthly payment lower and the total amount paid back lower.

Easier to get approved – Providing you have equity in an asset, secured loans are often easier to get approved for as the risk to the lender is lower.

Longer amortization – This can be both a pro and a con. Rolling your unsecured debt into your mortgage means you can repay it on the same terms as your mortgage which can be as long as 25 years. This means the additional monthly payment is very low compared to what you were paying. But even with a low-interest rate, paying it back over that length of time can be costly.

The cons
Your home (or other asset) is at risk – If you refinance your home and pay off your unsecured debts you have now put the house at risk if it isn’t paid. You have also reduced the equity in your home if you were to sell it.

As mentioned above, the term of a secured loan might also be longer than the term of an unsecured consolidation loan and this can considerably increase the interest you are paying.

The pros and cons of unsecured debt consolidation loans

The pros
The main benefit versus a secured loan is that you don’t need to pledge an asset as security and your home or other assets aren’t immediately at risk if you don’t pay. If you don’t pay an unsecured consolidation loan, the lender has the option to take legal action and try and lien your property if you have one. But this is a lengthy and costly process for them and one they would like to avoid at all costs.

Worse case: if you can’t pay an unsecured debt consolidation loan you have remedies to deal with it under the Bankruptcy and Insolvency Act or working directly with the creditor to settle the debt for less than what is owed. For secured loans, this option isn’t available unless you are willing to walk away from the asset the lender holds security over.

The cons
Approval can be hard – Unsecured debt consolidation loans were very common practice 5-10 years ago. Banks were wanting to provide them to you so you would become a client of theirs and payout your debts at other financial institutions, limiting the banking relationships you had.

Now the banks and lenders are reluctant to take on other bank’s debts and when you need it the most, you will find it the hardest to get approved. To qualify for an unsecured loan you will need a good credit score/rating and stable income to support the payments.

Higher interest: interest rates are generally higher than secured loans to reflect the additional risk.

Payments are higher: typically due to the higher interest rate and shorter repayment term your monthly payment will be higher and this might not make enough of a difference to improve your financial situation in the long run.

May require a co-signer: a co-signer is a person who agrees to pay the loan if you don’t. If you don’t have security to offer and your application isn’t an immediate approval based on your income and credit score, the lender may look to reduce risk by asking for
a co-signer.

If you don’t have good enough credit or enough income, having a co-signer that does will help assure you will be approved. If you don’t pay it back, they become 100% responsible for the debt and assume the same liability you have.

If you need a co-signer, the lender is saying they don’t think you can pay back what you are wanting to borrow and this should be a red flag for you.

Consumer proposals

Consumer proposals are one of the most effective debt options that Canadians can use to reduce their debt. While they have an impact on your credit rating, they often make good financial sense, helping the debtor save thousands of dollars and avoid losing assets through insolvency.

A consumer proposal is a formal arrangement filed by a licensed insolvency trustee under the Bankruptcy and Insolvency Act. It is a viable alternative to bankruptcy if your debts do not exceed $250,000 (not including debts secured by your principal residence).

The process allows you to make a new offer to your creditors to repay your debts on new terms.

The terms will include:

• The amount you are offering to repay.
• The monthly payment or lump sum payment you are offering.
• The number of payments; typically a monthly payment plan is offered over the maximum term of 60 months.

The proposal is your offer to the creditors and can be as unique as your situation. If you are a seasonal worker you could offer smaller payments during the offseason and increased payments when you are working.

The proposal process requires full disclosure of your financial situation including:

• All assets
• All liabilities (secured and unsecured)
• Your family situation
• Your family income
• If you have sold or transferred any assets in the last 12 months
• If you have sold, transferred or encumbered any real estate in the last five years.

The proposal will include an estimate of what the creditors would receive if you filed for bankruptcy and your offer should usually offer them a better return than a bankruptcy, otherwise, it will be unlikely the LIT will file it or recommend it and unlikely the creditors will accept it.

Make sure the offer you can make is affordable and not stretching you financially. If you miss three payments your proposal can be annulled and you will be back in the same situation you were before filing.

Who should file a consumer proposal?

If you are facing overwhelming debt that you can’t repay, and your debts are greater than your assets, then it might be a good option to consider filing a consumer proposal. You will need a form of income or access to a one-time payment to offer your creditors to settle the debts.

The proposal terms can be as unique as your situation. This is your proposal to the creditors, not anyone else’s, and should be structured on terms that work for you.

What are the benefits of filing a consumer proposal?
You can avoid bankruptcy and relieve financial stress by finding affordable terms to repay the debt. It will stop credit calls, wage garnishments, and legal action. It usually reduces the principal amount owed with interest-free repayment terms.

What are the negatives of filing a consumer proposal?
The main negative is the impact on your credit rating, reporting as an R7 for the length of time it takes you to pay off the debt plus an additional three years (reports for a maximum of 6 years).

Will the creditors accept my proposal?
After the LIT has submitted your proposal the creditors have 45 days to vote.

You need the majority in the dollar value of voting creditors to agree to the proposal. If a creditor doesn’t vote, they are still bound by the proposal once it is accepted.

The outcomes can be as follows:
The creditors accept the proposal on the terms offered – Once the creditors accept the proposal and it is approved by the courts, it is now a legal binding contract on all unsecured creditors. Your obligations are to make all payments as agreed and attend two counselling sessions.

The creditors reject the proposal outright – It is rare creditors outright reject a proposal. The only times this usually happens if they believe credit has been misused.

For example, if large amounts of credit are used just before filing, they can suspect fraud or that the information provided is not correct. If your proposal is rejected, you go back into the same position you were before. Your creditors can now pursue payment of the debt and you no longer have the legal protection the proposal previously offered.

The creditors reject the proposal but provide a counter offer – If the creditors provide a counteroffer, you can decide if you want to accept it, or go back with your own counteroffer.

Can I pay my consumer proposal off sooner?
Yes, there are no restrictions or penalties in paying off your proposal sooner. You can make lump sum payments or increase your monthly payments at any time to help pay it down faster. Paying it off sooner has benefits on your credit rating.

What’s the impact on my credit rating if I file a consumer proposal?
Technically it should report as an R7. This will report for the length of time it takes you to pay off the proposal plus an additional three years, with a maximum of six years. However, creditors may report it as an R9 until the proposal is paid off as there is still a chance you may not complete the terms.

Paying off the proposal as soon as you can will have a positive impact on your credit rating. After you have paid it off, check your credit report to ensure the proposal is reporting as fully satisfied in the public records section and that each creditor has updated their trade lines accordingly.

What if I don’t make the payments on my consumer proposal?
You can miss two payments. After that the third missed payment the proposal can be annulled, and you will then be back in the same situation as before filing the proposal. Making partial payments can delay the annulment if you can’t make the full payment. The annulment is based on $ value of 3 missed payments vs number of missed payments.

If you miss payments, you need to contact the LIT administering your proposal to discuss rescheduling the payments and/or look at other options available.

A change in your financial circumstance can affect your ability to make the proposal payments as agreed.

If this happens, be proactive and deal with it before the proposal is annulled. It is possible to amend the proposal based on the change in your circumstances. Amending the proposal will require submitting the proposal to your creditors as well as their approval.