Credit cards as a method of payment, are more popular among Canadians than ever. In fact the Bank of Canada reported that credit card use was on the rise, in terms of number and value of payments, while both cash and debit card use declined. And the increase occurred across almost all product and service areas, from gas to groceries, to meals and entertainment. What’s more, credit card use increased across all age, income and education level groups.
The following is a real client story from Alison Petrie, Licensed Insolvency Trustee. Alison talks about the long slow cycle into debt that one couple experienced as a result of their reliance on credit cards to balance their budget, despite being so careful with big financial decisions.
John (all names changed for confidentiality) works full-time while Michelle works part time with two preschool children at home. Knowing that their income was limited, they made as careful a decision as they could on the big purchases. Wanting a home for their family, they chose to live in a smaller house that they purchased three years ago for $150,000 and today their mortgage is only $118,000. They own only one car (a new one), but they were happy that their payments were lower than what they were paying for repairs on the old one, and with only one car, they needed to make sure it was reliable.
Despite this, John and Michelle came to see me because they had accumulated $70,000 in credit card debt. They just couldn’t understand how they had managed to accumulate that much credit card debt while trying to make good financial decisions around their home and car. Unlike your mortgage and car loan, debts like credit card debt and lines of credit are considered revolving debt. With revolving credit you can use the funds when you need them, don’t have to make fixed monthly payments and as you pay it off you can use it again. The problem with this type of flexible credit is that it can, and does, quickly get out of control and that’s what happened to John and Michelle.
Here are some danger signs John and Michelle could have watched for:
7 Credit Card Danger Signs
Not knowing your monthly expenses. Before John came to see me, he contacted a financial counsellor through his EAP at work and the counsellor asked how much the family spent in various areas. John didn’t know so he and Michelle got together one weekend, wrote it down and added it up. John was horrified to see they were spending more money every single month than they earned.
Using credit to create cash flow. John and Michelle were able to spend more than their income by using credit. If there wasn’t enough money in the bank account, they paid for necessities like food with a credit card. They thought this was just a temporary problem until payday.
Charging more than you are paying off. Most people don’t look at how much they owe on a credit card, they only look at the minimum payment. The minimum payment is very small and manageable, at least in the early days. For 2 years John and Michelle made the minimum payments on the cards quite easily. Because they focused on the payment, rather than the balance, they didn’t notice that every month they charged more on the credit card than was paid off, and that they were getting deeper in debt every month.
Stalling one creditor to pay another. This is commonly known as “robbing Peter to pay Paul”. You take a cash advance on one card to pay the minimum on another. Eventually, you skip a payment on one card this month and skip a payment on another card the next month. Soon the creditors start calling about the skipped payments. For John and Michelle, this is when the stress levels really began to rise.
No savings or emergency plan. The reason John and Michelle turned to credit cards each time a small cost came up was because they didn’t have any cushion in the form of savings to rely on. Without an emergency fund, John and Michelle couldn’t weather the impact of even small demands for cash. Life will always throw you curve balls. You must have some savings so you can pay for non-regular, random occurrences. On the surface their decision to spend less on a car payment rather than car repairs seems sensible, but the car payment comes out of their bank account and further depletes the cash available for other unplanned costs like a wedding invitation, dental bills or house repairs.
Running out before payday. The final straw for John and Michelle was the fact that eventually they found themselves short of cash each and every payday. This is not an uncommon side effect of continuing to use credit. As your credit card bills increase, so do your minimum payments. Now debt payments take up an ever increasing share of your paycheque. In extreme cases you go out and get a payday loan to buy groceries because your paycheque is going to pay interest on your credit card debt.
Consolidating debt and racking up the mortgage. Desperate to reduce their credit card debt, John and Michelle considered a debt consolidation loan. The problem was, with $70,000 in credit card debt and only $30,000 or less in home equity, a debt consolidation loan was only going to take care of part of their debt. And if they didn’t deal with all the credit card debt, John and Michelle were deathly afraid they would end up losing their home.
That’s when they came to see me. We talked about making a consumer proposal which would allow them to offer a deal to their creditors to settle all of their $70,000 in credit card debt for roughly $35,000. This amount was based on the equity value in their home, plus an amount based on John’s income which was fairly good. They were able to spread the payments over five years. When combined with some budgeting advice, John and Michelle found they were able to balance their budget and even get ahead on their savings, without using credit cards to survive.
If you are paying off your balances in full each month, using a credit card to pay for purchases makes a lot of sense. You earn points, there is no need to carry large amounts of cash and there is some added security in being able to cancel your card if your wallet is lost or stolen. However, these benefits are quickly overshadowed by interest costs if you can’t eliminate your credit card debt. Credit cards can swiftly morph from an ease of payment tool into a way to make ends meet. In effect, your credit cards change from a ‘credit’ tool to a ‘debt’ tool.
Do any of these “danger signals” or “symptoms of financial problems” sound familiar? Are you struggling to repay large credit card debt balances? If so, give us a call to book a free consultation where we will help you develop a plan to eliminate your credit card debt and start over financially.
UPDATE: Since this podcast was recorded, Affirm Financial Services has discontinued offering credit cards to people in an active bankruptcy in most cases, so the information in this podcast is for general information only about secured credit cards. If you are looking for a secured credit card AFTER your bankruptcy is complete, an option is a Secured Home Trust Visa Card.
Today we look at card options for those with damaged credit, specifically a secured credit card.
What does a secured credit card offer?
One of the biggest worries people have about filing bankruptcy or a consumer proposal is the loss of their credit cards and their credit history.
An option for many of our clients to to apply for a secured credit card. Like any credit card, a secured credit card is a transaction based card so you use it for daily transactions like renting a car, booking a hotel, buying something online.
A secured credit card is a real credit card, with real credit limits and is reported to the credit bureaus meaning using the card (wisely) can help you rebuild your credit. By using a secured card, and paying your balance off each month, you begin the process of re-establishing your credit.
No one outside of the credit bureaus knows the formula that goes into generating a credit rating, but some areas that are taken into consideration include the length of time you’ve had credit, your payment history and how long that history is, demographic information, recent inquiries made by financial institutions and the utilization of credit.
Having a credit card and using it wisely are good ways to begin the process of rebuilding credit.
So how much credit do you need?
Most people get a secured credit card for between $500 a $1,000. That amount is easy to save up during your bankruptcy or proposal and generally provides enough to cover reasonable charges and be able to pay that amount off in full each month.
However access to a bigger amount of credit, but only using a small portion of it shows that you’re using that credit responsibly. So should you save up more & apply for a larger limit?
It is often over-use of credit cards and build-up of overwhelming credit card debt that lead to financial problems in the first place. Having a higher limit, even though it is secured, still requires you to be able to pay off any balances you charge on the account every month if you really want to start creating better credit card habits. Can you do this if you give yourself a higher limit?
Whether you should get a secured credit card, and for how much, is a decision that will have to be made by you based on your specific personal situation. At Hoyes Michalos, we never advise anyone to get a credit card during or right after bankruptcy unless they absolutely need one or they have a future need for good credit. You’ve lived without a credit card during your bankruptcy. It may be possible to continue to do so after your bankruptcy is completed.
If you must get a credit card, either during or after bankruptcy, follow these tips:
Use your card as a substitute for cash, not a substitute for borrowing;
Make sure that you are disciplined about making your monthly payments and don’t carry a balance;
Replace the high interest card with a less expensive one once you have rebuilt your credit.
As I record this show in June 2015, interest rates are at record lows. If you have perfect credit, you can get a conventional mortgage for 3% or even less. With good credit you can still get a car loan at close to zero interest. But what happens if you have less than perfect credit? The answer is that in many cases your only option for credit is through a high interest loan or a high interest credit card. And I can tell you there are lots of lenders willing to lend at high interest rates to people with less than perfect credit.
When I started out in the debt help business 25 years ago the big players were the finance companies, many of whom no longer exist. Today it’s not the finance companies that dominate the market. If you have poor credit your options are the higher interest lenders including some specialized finance companies, as well as payday loan companies and high interest credit cards.
So, what’s the deal on high interest credit cards for people with damaged credit? Are they a good deal or should they be avoided at all costs? To find out I’ve asked a provider of credit cards to people with bad credit to be a guest on the show. Before I introduce him, let me give you my standard disclaimer. The guests on this show, Debt Free in 30, are invited by me because I want to hear their perspective. I don’t just invite people I agree with. I also want to make it clear that I don’t pay any of my guests to appear on the show and none of my guests pay to be on the show. Debt Free in 30 is not a commercial for any of my guests; it’s a forum for my listeners and for me to hear many different points of view.
So, with that background let’s get started with today’s guest. Who are you? Where do you work and what do you do?
Jim D: Well, thanks for having me Doug. My name is Jim Dunbar. I am the Managing Partner and Chief Commercial officer for Affirm Financial Services.
Doug H: So, tell me a bit about Affirm Financial Services, then. That’s obviously not a big bank.
Jim D: We are a finance company. We are a Canadian based finance company. We’ve been in market now for a little over four years serving Canadians. We provide consumer loans, term loans and credit card solutions to customers who are not being served by the banks. That’s probably the best way to describe it.
Doug H: Great, okay. Well, thanks for being with me here today, Jim. So, let’s talk about the credit card product. As I understand it Affirm Financial has a credit card that you can qualify for even if you’re bankrupt or in a consumer proposal. Is that correct?
Jim D: That’s correct. We have designed the product for people that are in bankruptcy or consumer proposal and for those who have been recently discharged.
Doug H: Okay. So, and I understand the need for such a thing. And in fact the question I get asked all the time by somebody who’s thinking about going bankrupt is, yeah but if I go bankrupt I know I lose all my credit cards; how am I going to be able to book a hotel room cause I have to travel for work? I give them some advice on how to go about doing that, having family or friends get you a card for example, or have your employer get you one so it’s not really your card, you’re just able to use it. But a lot of people don’t have that option; they don’t have a family or friend who’s willing to give them access to a credit card. So, that’s where a service such as yours comes in. But, obviously there’s some costs associated with that.
So, let’s go through the main points of this credit card that you’ve got. So, what’s the credit limit that you offer? And let’s take the case of somebody who is currently bankrupt.
Jim D: Well, if somebody is currently in the process and currently bankrupt, the maximum credit limit is $1,000. When someone comes out of bankruptcy and has been discharged, that limit goes as high as $4,000.
Doug H: Okay, so during the bankruptcy period $1,000. What security deposit is required on that card?
Jim D: That’s a good question. There is no security deposit required on the card. And I think that is probably the most important description here: this is not a prepaid card and this is not a secured card. This is an unsecured credit card; it’s an actual MasterCard that is made available for our customers.
Doug H: So, what are the qualifications terms then in order to get this card?
Jim D: We do offer this card to people that it’s the first time they’ve been bankrupt. And that they have a source of income. We verify that source of income; we think that ensuring that someone has the capacity to pay back and make the monthly payments is critical, but once that’s been demonstrated we’re able to offer the card.
Doug H: So, okay we talked about all the good things. You know, it’s got $1,000 credit limit, even if you’re bankrupt so long as it’s your first bankruptcy. So long as you’ve got a job or a source of income you qualify, there’s no security deposit required. Obviously there is a catch. What is the monthly fee on this card?
Jim D: There is a monthly fee, it is $7 a month and that’s the only fee associated with the monthly use of the card.
Doug H: So, even if I don’t use it, even if I don’t borrow any money, I’m paying $7 a month. What is the interest rate if I have a balance owing?
Jim D: The annual interest rate on the card is 28.8%.
Doug H: So, just under 29%. So, okay so let me play devil’s advocate here. Every bank in Canada has a credit card and the typical interest rate is I don’t know 19% or lower, and most basic credit cards have no monthly or annual fee. So, why should someone consider your card which has a higher interest rate and has a monthly fee?
Jim D: I think that’s a great question and it’s one that I’m happy to talk about and it’s one that we’re very open about with our customers. The reason our rates are a little bit higher than the bank is simple. We’re not a bank. We borrow our money from the bank. So, our cost of funds are automatically a little bit higher than the bank. And in addition we are also taking on some additional risk in order to provide our service, which the bank isn’t able to provide. So, it costs us a little bit money and that is reflected in having a monthly fee.
But I do want to be really clear. We’re not suggesting that we’re trying to compete with the bank. We’re offering a very competitive rate product to people where they’re not able to get financing from a bank. And in fact, part of our conversation with our customers is, when you can get traditional financing or you can get a card with a different interest rate at a bank, we encourage that, and we support that by not having any fees associated with paying the card out early or paying a loan – more specifically paying a loan out early. We don’t have fees associated with that. We want people to get the best rate they can. When they can’t we think we’ve got a very competitively priced product.
Doug H: So, you think your typical customer will only be with you for a limited period of time during their bankruptcy, maybe for a year or two or three after their bankruptcy is finished or until they’ve re-established their credit in some other manner. You don’t expect you’re going to have anyone with this particular card for 10 years is that correct?
Jim D: Well, I think that’s absolutely the way to look at it. The card is there at a time when you need to start either establishing credit or you need to re-establish credit. It is a transaction based card so you use it for daily transactions we mentioned earlier, renting a car, booking a hotel, buying something online. It really is designed to be a daily transaction card. The idea is that you pay it off every month. We keep the limits very manageable. And when you can find a card that’s cheaper, that’s absolutely what we would promote.
Doug H: It still sounds kind of to me that you’re kind of taking advantage of people. So, a normal credit card rate would be maybe 10%, 15%, 20% with no fee, with yours, you’re paying $7 a month. So, even if I don’t use the card that’s still $84 a year. Wouldn’t I be better off taking that $84 putting it in a savings account so at the end of the year I’ve got $84? Go out and use that money, go out and use that money to start re-establishing your credit. It’s – again, it seems to me like such a high number. Do you perceive that you are taking advantage of people?
Jim D: Absolutely not. I think that the price is really designed to be there to provide a facility and utility for someone to have a credit card. There are secured cards out there. This is actually a credit card. This is a real credit card. It has a real credit limit assigned to it. It has an ability for you to use it and to gain credibility at the credit bureau for purposes of your credit reporting. We report all credit payments to the credit bureau, and it is a $7 fee a month, but we kind of look at it as for $84 a year you have the utility of a card, you have access to actual unsecured credit card and you’re building credibility with every payment you make on it to support your credit bureau score.
Doug H: Well, and that’s another good area to talk about then, building your credibility, supporting your credit score. I’d like to talk more about that and I’d like to hear your thoughts on, okay is this really building my credit score or is that really just more of a sales pitch you’re making?
But before we talk about that let’s take a quick break and we’ll come back and talk about whether or not a credit card like this can actually help improve your credit score. We’ll be right back. I’m talking to Jim Dunbar of Affirm Financial; you’re listening to Debt Free in 30.
Announcer: You’re listening to Debt Free in 30. Here’s your host, Doug Hoyes.
Doug H: Welcome back. I’m talking today with Jim Dunbar who is with Affirm Financial Services. They offer a credit card that people can get even if they are bankrupt, even if they’re in a consumer proposal or even if, for whatever reason, they have very challenged credit.
And before the break we were talking about the parameters of this card: there’s a $7 monthly fee, the maximum credit limit is $1,000 if you are bankrupt at the time you get the card, the credit limit will increase (or can increase once you’re discharged from your bankruptcy), and there’s also an interest rate of 28.8% if you’re carrying a balance every month, which I think kind of defeats the purpose of a credit card like this, but that’s the perimeters.
So, I said to Jim before the break, that’s awfully expensive isn’t it? And he said, yeah it’s expensive but there are number one, not a whole lot of options if you need a credit card while you are bankrupt cause you need it for work you need it to book hotel rooms then this an option. So long as you pay it off every month the cost is $84 a year for that credit card. You’ve got to decide for yourself whether that makes sense.
Now the other point that Jim made just before we went on break was that this also actually helps you improve your credit score. So, let’s talk about that. And maybe we can start with some basic definitions here. What are the kind of things that go into your credit score? And I know Jim, you’re not a representative of Equifax, neither you nor I know their secret formula, but give me a bit of an overview of the types of things that go into a credit score and then we can bring it back to this card in particular.
Jim D: Sure. Well, I like this question and you’re right. I’m not representing the bureau on this answer, but I can tell you about some of the specifics that do drive the score. It’s a difficult question to answer but it is one – and it’s difficult cause it calculates so many different variables and it’s very specific to an individual’s actual credit information. So, there are a lot of different calculations that go into it.
But to give you some examples it looks at things like the length of time that you’ve been on the credit bureau, looks at things like payment history, it looks at how long that payment history has been in effect. It looks at very unique demographic information, specific to the individual. It looks at things like recent inquiries, where financial institutions may have been or whether or not the person has been seeking credit. It looks at – a very important one is utilization of credit.
So, it does a calculation and looks at of the credit that you have available to you, how much of it have you used and how well are you paying it back as per the terms? So those are examples of the kinds of things that really can impact somebody’s score and so there are a lot of calculations but those are the kinds of things that people can be aware of.
Doug H: Okay, and we’ve talked before on this show about credit scores and how they work. And I’ll put some links in the show notes to some of that information.
So, okay we understand there’s a bunch of parameters that go into it, do you have any evidence that your specific card actually helps? I totally agree with you, the longer my payment history the better my utilization, the better my credit score but what about your card in particular? Do you have any evidence that your card actually helps people improve their credit score?
Jim D: Well again, I think it’s important to note that it’s one variable in a series of quite a few calculations. But we did do a sample of 2,000 of our accounts. We looked at accounts that were in bankruptcy or some that had been recently discharged and we took a sample of 2,000 accounts dating back to 2012. And we looked at those accounts and we were very pleased to see that over 65% of those accounts in that category had a score range of 675 or better. What that score really means is, the banks kind of look at between 700 and 675, 680 as where they have a cut-off if you want to call it that. That’s a range I’m guessing a little bit, that’s about where they are. 65% of the accounts that we looked at in that very short amount of time, had now achieved that rate. And we know that part of that process is impacted by the fact that they had an active credit card with us that they were paying according to the term. So, they were paying it well and their scores were going up.
Now there were other factors but it’s a really good indicator. 43% of those accounts were up over 700 so that is a really impressive improvement for those accounts, which we know can have, or were having some impact.
And I think what’s important is we’re trying to give people the ability to start making that impact sooner. So, while people are in bankruptcy they’re using that card and they’re getting that benefit and they’re creating that history. And I think that’s a really important distinction about what this card can do because it really is trying to get the process started earlier.
Doug H: Do you have any knowledge of what the person’s credit score would have been prior to starting? So, what you’re saying is we looked back and somebody who got our card a year or two ago may very well have a credit score of 700, which is starting to get into a decent range. But, did that person have a credit score of 700 two years ago anyways? Do we have any way of knowing whether the card was actually a contributing factor to that?
Jim D: Well, I can assure you that all – they’re very unique, but it’s very difficult for me to give you that level of detail, because we have to aggregate the results. But that said, I think there would be very few to any that would even have been anywhere near that range. Because of when they applied for credit, their credit scores were actually quite low. They were as low as four or five or low 600’s, most on average. So, really we’re talking about accounts that probably had very poor scores that actually made some pretty dramatic improvement.
Doug H: And I understand that obviously you’re not going to release individual client information here, that’s not possible. But what you’re saying is you’ve taking a sample of a couple of a thousand people and you took a look to see – well, you know roughly what their credit scores are when they start the program because they are either in bankruptcy or just out of bankruptcy, they’re in a consumer proposal or for some other reason they have not great credit. And those people would typically have scores of you know, 400, 500, high 500’s maybe into the low 600’s. And by the time a year has gone by, or two years have gone by, obviously being discharged from bankruptcy is going to have a positive impact on their score, but a significant chunk of those people now have a credit score of 700 or higher. That’s what you’re saying.
So, does having a higher credit limit matter? So, I can go out and get a secured Visa card for, you know, let’s say with a $500 limit. I can get your credit card even if I’m bankrupt up to $1,000 limit. Once my bankruptcy is finished the limit can increase. Does size matter when it comes to the outstanding availability on your credit card?
Jim D: Yeah, I think I’ll answer that question; the answer is: yes it can have an impact. And I think the best way to describe it probably would be with an example. So, if someone has $1,000 credit limit and on average they carry or use $500 of that in a particular month or on average that’s what they use, their utilizing 50% of the credit that they have available. If somebody had that same payment pattern, and they had a limit of $2,000 on the card, now they’re using half of that (so 25% of the available credit).
And what the calculation is really looking at is a bit of size matters so it does matter what the limit is and then, but a more important calculation is really how much of what is available to you have you used and I think that – so limit can make a difference, but it is consistent with if your spending habits stay consistent. And that’s probably the better way to approach that question.
Doug H: Yeah and we don’t know what the exact formula is with the credit bureau, but the people I’ve talked to have told me that, yeah utilization of 20% is a lot better than a utilization of 80%. So, the bigger amount of credit that you have access to, but you demonstrate you’re responsible by using only a small portion of it, therefore makes a difference.
So, I guess the concluding comment then in this segment would be that the $84 a year that it’s going to cost me to pay the $7 monthly fee on a $1,000 credit card is actually also helping improve my credit score longer term. Is that essentially what you’re saying?
Jim D: Yes, absolutely.
Doug H: Okay, well that’s very helpful information. I know you also have a term loan product. And we’ve only got about a minute here but the term loan product is something once you’re bankruptcy or once your consumer proposal is finished. Is that correct?
Jim D: That’s correct.
Doug H: And the maximum you can get on that term loan would be how much?
Jim D: It would be $5,000.
Doug H: And the interest rate on that would be how much?
Jim D: Those interest rates also start at the 29% range.
Doug H: And could be a bit higher than that. And what’s the monthly fee on those loans?
Jim D: There are no monthly fees. So it is just an annual percentage rate and I think what’s worth noting on these, these are also unsecured loans and they are open, they have a term to them, but if someone would like to pay it sooner or pay it faster than the term there are absolutely no penalties to that. So, if someone can borrow the money at a better rate throughout that term, we encourage them to take advantage of that and there are no penalties associated with paying it sooner.
Doug H: And in effect you’ve already said that in the first segment what you’re really trying to do is get the person into a better position. And you assume that five years from now they’re probably not going to be your client anyways because their credit will be such that they can borrow at a better rate. So, I think that’s a great way to end this segment. Jim, thanks for being here today.
Jim D: Thanks very much for having me.
Doug H: Great thanks very much. We’ll be back to wrap it up right after this on Debt Free in 30.
Doug H: Welcome back. It’s time for the Let’s Get Started segment here on Debt Free in 30. My name’s Doug Hoyes and my guest today is Jim Dunbar of Affirm Financial Services. His company offers products to help people rebuild their credit and one of the products is a credit card. The credit card carries an interest rate higher than what you’re going to get at the bank. It also carries a $7 a monthly fee, but it’s a fully unsecured credit card, meaning you don’t have a security deposit and you can get this credit card as soon as the bankruptcy starts.
Now what I want to talk to you about in this segment, Jim, is what is your advice to somebody who wants to rebuild their credit, because this is kind of the common question I get from everybody. Okay, I’ve had issues in the past, I lost my job, I went through a marriage separation or divorce. I had some medical issues, I had to go bankrupt but I want to get back on track again. Someday I would like to buy a house, finance a car. I want to have access to credit. So, what are the steps that need to be taken?
And obviously, the obvious steps are well you’ve got to cut your expenses so they’re below your income; you’ve got to be saving money and things like that, but to build up your credit you have to have things on your credit report. And as we talked about in the previous segment, time matters. So, what in your mind then is the first step? Would it be to, perhaps after you’ve built up a bit of savings or something in your bank account, would it be to get one of your unsecured credit cards?
Jim D: Yes, I think the very first thing I think is to understand what is an affordable monthly payment for you and what’s the right kind of credit? I think a credit card would be a great place to start. The important thing is, the sooner you start, the sooner you start to improve the benefit of having- establishing new credit and making the monthly payments. The second probably most important thing is that you use the card within the means that you’ve established so that you are paying the credit back and paying either the monthly payment or the entire balance off every month, so that you’re continually getting that credit and helping to establish yourself back at a credit bureau.
Doug H: Yeah, and my advice of course is going to be okay I understand why a credit card may be necessary; you need to have a credit card to book a hotel room to do other things, and you also want the added benefit of having it begin to rebuild your credit, so that kind of makes sense. I am not a big fan of carrying a balance on a credit card whether you’re bankrupt or not, whether you got lots of money or not. I don’t think that’s the way you should be borrowing. Obviously, your business model is such that well yeah we don’t mind if people are carrying a balance so long as they’re making the minimum payment that’s obviously how you enhance your revenue.
So, I get the credit card at the end of my bankruptcy, what happens then? So, I’ve been paying my credit card every month doing a great job, at what point then am I able to increase the limit on that card?
Jim D: The limit can be increased once someone is discharged for bankruptcy. So, we’ve set up the program where we’ve tried to offer a limit that provides value for the purposes of transactions, but once out of the discharge we’re able to look at it and apply a different approach to the credit limit. I also want to – I do agree with you, credit cards are not designed to be a means of borrowing and I think it’s really important that people think about a credit card for the purposes of a transaction and they pay if off every month. And I think that’s probably the most important part of this message. Once someone comes out of that process, there are means and people would like to have a higher limit and that’s where we approach things a little differently and we have limits for both the loans and cards once someone comes out of discharge that are higher.
Doug H: Yeah the credit card should be a substitute for cash, it shouldn’t be a substitute for borrowing. That’s what it’s there for.
Jim D: Yes.
Doug H: So, my bankruptcy ends. I call you guys up, maybe you bump my credit limit up to $1,500 or $2,000 or whatever, and am I still paying the same $7 monthly fee or does that go up?
Jim D: No, that rate stays the same. And what we are able to do is start to look at, based on credit payment performance and where you are in that process, a higher limit.
Doug H: And at that point then I could also apply for a term loan so that I then have two different things in my credit report and so that I have higher credit which then factors into the whole utilization category we talked about. So, at what point would someone be able to apply for a term loan?
Jim D: Yeah once they’re discharged from bankruptcy you can apply for the term loan. And I think the term loan really is designed to provide a short-term cash need that has an end date in sight. So you borrow the money with the idea that at a specific term you pay that money off.
Doug H: Yeah, the goal is not to have a loan that’s going to be there forever. Maybe it’s okay I’m going to borrow the money and I need to buy a really inexpensive car, I need to do some car repairs or something specific. So, I have the loan for a year or two years whatever, but I get it paid off and hopefully at that point in time once it’s paid off my credit is therefore better. Is that really the whole concept?
Jim D: Yeah, that’s the whole concept and both credit facilities do help to provide you with improvement in the credit score.
Doug H: Yeah, so I guess the advice for people then is crunch the numbers, I’m certainly not going to tell you you should get a credit card or a loan or you shouldn’t. You’ve got to look at your own individual circumstances and decide what’s going to make sense for you, great, thanks very much for joining me today, Jim.
Jim D: Great, thanks again.
Doug H: We’ll be back to wrap it up on Debt Free in 30.
Announcer: You’re listening to Debt Free in 30. Here’s your host, Doug Hoyes.
Doug H: Welcome back, it’s time for the 30 second recap of what we discussed today. On today’s show Jim Dunbar explained the features of their credit card product for people who are in bankruptcy or who don’t qualify for a credit card from a traditional bank. That’s the 30 second recap of what we discussed today.
As I said during the show, these credit cards carry a monthly fee and a high interest rate. So you should only get one if you have no better options and you will be disciplined enough to pay it off every month and to replace it with a less expensive option once you’ve rebuilt your credit.
Doug H: That’s our show for today. Full show notes, including links to the products we discussed on today’s show are available on our website at hoyes.com, that’s h-o-y-e-s.com. Thanks for listening. Until next week, I’m Doug Hoyes. That was Debt Free in 30.
Before now, there really were no rules governing debt settlement companies in Ontario, which meant that they could charge large up-front fees, only to refer the client to a bankruptcy trustee once legal action was taken by a creditor. The process has already started and on January 1st, 2015 the Collection Agency Act was renamed the Collection and Debt Settlement Services Act.
Today I sit down with trustee in bankruptcy and co-founder of Hoyes Michalos, Ted Michalos to talk about the new legislation and what it means for consumers.
So why is this important? We often hear that clients are afraid to seek help from a trustee in bankruptcy because of the stereotypes and misconceptions about the process. Debt settlement companies feed off this fear by placing ads claiming to be able to settle their debts for pennies on the dollar, while avoiding bankruptcy. Unfortunately, more often than not, these informal debt settlement companies fail, hurting the consumer both emotionally and financially. The new debt settlement legislation attempts to protect consumers from these abuses.
We’re not pro or anti debt settlement and in some cases it can be a good option. It is not for us to say that every debt settlement company is not reputable. What we address today is how, and if, the legislation levels the playing field and what other options debtors have to settle and eliminate their debt.
Story time with Ted: Fred’s story
Like many Canadian consumers, Fred just couldn’t get ahead of his debts and the collection calls were beginning to pile up. Fred saw an ad that boasted “avoid bankruptcy and reduce your debt by 70%!” So, Fred called the number and they offered him a debt settlement plan.
The Plan: Fred owed $50,000 and they were going to settle for $15,000. Payments each month would be $500 for 30 months plus a fee of $3,000 to the settlement company. So in total Fred was expected to pay $500 a month for 36 months.
The Catch: Since the debt settlement company wants to be paid up-front Fred’s first six month payments of $500 a month, were actually paying for the company’s fees and not going toward his debt at all. Two months in, Fred received a notice from a creditor that they were taking legal action against him for non-payment. When confronting the debt settlement company, they advised him that he needed to seek legal protection in a consumer proposal or a personal bankruptcy. This after Fred had already paid the debt settlement company $1,000 in fees, for nothing.
The Take-Away: The old debt settlement rules (or lack thereof) meant that companies could charge big fees, and in most cases, not really accomplish anything on behalf of the consumer. In fact, the Canadian Bankers Association has said that only about 10% of deals that banks receive from debt settlement companies, are actually accepted. If Fred had gone directly to a trustee in bankruptcy, he could have avoided up-front fees (all first consultations are free), and he would have received immediate legal protection through a stay of proceedings.
What’s included in the new debt settlement legislation?
No big up-front fees (with the exception of a $50 administrative fee for each account outstanding). Previously, companies could charge thousands in fees (consider Fred’s story) before ever attempting to make a deal with the creditors.
Because the debt settlement company can only charge fees as a payment is made, that likely means the deal has been agreed to by the creditors before any payments are made by the debtor.
Fees have been capped. The debt settlement company is only entitled to 15% of each payment or alternatively, 10% of the total if you’re settling using a lump sum payment.
Ted’s predictions
So what will this new law mean for Canadian consumers? Ted explains that,
this is a good first step because it immediately cause[s] a number of people who I think [are] less than reputable, to rethink their whole business model. They [can’t] charge fees up-front so it [is] time for them to get out of the business.
Ted also predicts that although it will change the way that they do business, those in the debt settlement industry will morph into other agencies not regulated under this new law, including debt consultants and debt coaches; leading to repeat problems under a different guise.
Consumer proposal versus debt settlement plan
If you’re facing overwhelming debt, don’t be fooled by the quick fixes that some companies claim to be able to provide. If you want to deal with your debt, but avoid bankruptcy, a consumer proposal could be the right answer. A consumer proposal can only be filed by a federally licensed trustee in bankruptcy and as soon as you sign the paperwork, you are legally protected from creditors who may be threatening to garnishee your wages or sue you for non-payment. Ted explains that
under the Bankruptcy and Insolvency Act, you file a consumer proposal, you get an automatic stay if proceedings, which means no legal actions can continue or be commenced against you until we figure out what’s happening with the proposal.
Unlike a debt settlement plan, a consumer proposal is legally binding and regulated by the Federal government under The Office of the Superintendent of Bankruptcy,
so you’re not out of pocket for somebody that’s hopefully going to make a deal for you. You know the deals in place and you’re protected under the law.
On July 1st, 2015 some new laws will take effect in Ontario and these laws are laws you’ve probably never heard of. So, to talk about that I’m joined by my Hoyes Michalos co-founder and business partner, Ted Michalos. Ted, how are you doing today?
Ted Michalos: Fine Doug, how’s it going?
Doug Hoyes: Great. So, talking about legislation is boring. No one wants to hear you and me start reading sections of the new law.
Ted Michalos: Including you and me.
Doug Hoyes: That’s right. We don’t want to do that. But this is an important new law and it will impact a lot of the people listening to us today. So, I thought we’d start with a different approach. So, we’re going to do a brand new segment here and I’m calling it Story Time with Ted.
Ted Michalos: How exciting.
Doug Hoyes: Isn’t that a great title? So, over the last 20 years you’ve probably met with I don’t know, 10,000, 20,000 people and I know a lot of those people have gotten burned by the topic we’re going to introduce today.
So, I want you to tell me a story about someone you’ve met with. Now I don’t want real names. I don’t want you to tell me what their job was or even what city they lived in cause obviously when we meet with people we don’t want to talk about it on the radio. So, I’m going to make up the guy’s name. The guy’s name is Fred. So, Ted I want you to tell me a story about Fred.
Ted Michalos: Well, this is pretty easy because I meet with people like Fred all the time. In fact it’s distressing how often people respond to these debt settlement ads.
I’ll give you Fred’s story in a nutshell. So, about four months ago he decided that he was in financial trouble. He just couldn’t make his payments every month and he was worried about the collection letters. He was starting to get behind. So, he saw an ad that said reduce your debt by 70%, avoid bankruptcy. Well, that sounds like a great solution. So, he called the number, met with a fellow, and he said look what we can do is we’re going to put you in a debt settlement plan. You owe $50,000 Fred, we’re going to settle for $15,000 and you’re going to make payments of $500 a month for the next 30 months to deal with it. Well, actually it’s going to be 36 months Fred cause you’ve got to pay us some fees first. And that was the catch.
So, the first six months payments of $500 a month were going to the settlement company as a fee. Fred got two months into it and then he got a notice from small claims court, one of his creditors was taking legal action against him. Well, he called the settlement company and they said, well when I signed this deal with you, you told me to refer all these people to you, to forward the collection letters to you, to tell you whenever anybody called and I did all of that and now I’m getting sued. And the debt settlement company simply said well, you know what? You need legal protection now you’ve got to go to see a trustee and do a consumer proposal or possibly file bankruptcy. So, Fred’s out $1,000 for nothing.
Doug Hoyes: And Fred actually didn’t do too badly cause we’ve talked to lots of people who’ve been out a lot more than that, $2,000 or more.
Ted Michalos: First thing I said to Fred was I guess you’re lucky it wasn’t six months into it.
Doug Hoyes: Yeah, cause you would have had to pay even more. So, there you go, there’s our first edition of Story Time with Ted. And obviously the subject of today’s broadcast is debt settlement. It’s something we’ve kind of touched on on a few previous shows but we’ve never done a whole show on it. And we’ve never talked about the new rules that are coming into effect in Ontario.
So, I think Ted in the story you just told there were two key components. The first one was big fees, these guys charge a lot of money and the second component was that in a lot of cases nothing actually happens. And I’m going to put a link in the show notes. But the Canadian Bankers Association who should know, these are the guys who represent the people who we’re paying the money to; they said that only about 10% of deals that banks receive from debt settlement companies are actually accepted. So, that doesn’t mean they’re actually paid in full, that means they actually accept the deal up-front. Does that make sense to you?
Ted Michalos: Yeah the stat that we were told was less than 3% are ever successfully completed. So, your 10% stat doesn’t surprise me at all, but 3%, that’s three guys out of 100, where the solution actually works.
Doug Hoyes: So, debt settlement almost never works, that’s the whole point. So, before we talk about the new legislation what you just described in Fred’s situation sounds a little bit like a consumer proposal. We go to the creditors and make a deal. So, what is the difference between a debt settlement and a consumer proposal?
Ted Michalos: Well, a couple of critical elements. The first is the debt settlement companies allowed to charge their fees up front before any work gets done. So, there’s no deal in place you don’t know that the solution’s going to work. And as we just said in the vast majority of cases, the solution doesn’t work there isn’t a deal to be had, you’ve already paid the fee.
But more importantly a consumer proposal is a legal procedure. There’s a very specific set of rules and regulations surrounding them and you’re afforded immediate protection under the law. So, Fred got sued two months into the plan that he was trying to do, that can’t happen in a consumer proposal. There’s something called a stay of proceedings that immediately stops legal actions against you. That’s probably the biggest difference. The second is you’re only paying fees when the deal is made and then money is forwarded to the creditors. So, you’re not out of pocket for somebody that’s hopefully going to make a deal for you. You know the deals in place and you’re protected under the law.
Doug Hoyes: So, in a consumer proposal, I come into you, I’ve got a bunch of debts, you crunch the numbers and you say okay the proposal we’re going to make is $400 a month for the next four years to your creditors.
Ted Michalos: Right.
Doug Hoyes: So, how much do I pay up-front?
Ted Michalos: Well, presumably you don’t pay anything up-front. Now it all depends on the local trustee offices you’re dealing with. In our policy we want you to make you first payment in the first month. A lot of trustees charge you an initial payment on day one. Some of them don’t charge anything until 60 days into it. It literally depends on your financial situation and the terms of the deal. But that first payment is going directly towards the settlement. So, if the deal is to pay $400 a month for 48 months, you’re not putting $400 in the trustee’s pocket, you’re putting $400 into the deal.
Doug Hoyes: So, I come into you on day one and let’s say I say to you Ted I get paid every two weeks so it would be a lot easier if instead of paying $400 a month I paid $200 every two weeks. Could I do that?
Ted Michalos: You can and that’s the smarter way to do it too, because you’re actually making extra payments that way.
Doug Hoyes: Okay, so I pay $200 every two weeks. So let’s say my first pay cheque is two weeks from now. So, I can make my first payment in two weeks and every two weeks thereafter $200.
Ted Michalos: Correct.
Doug Hoyes: So, when do I know that the creditor said yes?
Ted Michalos: So, when you file a consumer proposal, the creditors get 45 calendar days to respond to the trustee’s office. So, that means weekends, holidays don’t matter, it’s 45 days from the day you start. They can say yes, they can no or they can counter offer. Once the creditors have made their opinion known, you’ve got another 15 days when you can still change your mind and say you know what, this isn’t the solution I thought it was going to be. That almost never happens but the provision is there in the law.
Doug Hoyes: So, worst case scenario I guess I make payments to you for 45 days, maybe one or two or three bi-weekly payments. If the creditor’s say no, I could be out those 45 day payments, but I actually did get some protection during those 45 days though, even if the creditors said no?
Ted Michalos: Well, you did and I’m probably giving you the wrong impression here. So, if the creditor’s saying no, they almost always counter offer. So, let’s go back to the example we’ve been using and it’s not a typical example actually, the numbers are a little high. You’ve done a deal; you’re offering $400 a month for 48 months to settle on your debts. The creditors come back and say you know what, we’d like you to pay that $400 a month for 60 months. So, they have counter offered. They said no to the first one and they’ve given you a second one. I think the statistic is something – it’s something phenomenal, 99% of all the proposals that we offer in our firm are accepted either as filed or as amended.
So, it’s unusual for you not to have a deal. In fact the only cases I can think of where no deal was possible, was because there was something unusual about the circumstances; for instance Fred borrowed $20,000 to buy a pick-up truck from T.D but he didn’t actually buy the pick-up truck. So, TD has some concerns where the money went. But that’s not the norm.
Doug Hoyes: Yeah, they’re usually unusual situations like I owed a huge amount of money to Revenue Canada and I didn’t file my taxes or something, well they may be less willing to make a deal. So, in 99% of the cases when someone comes in to file a consumer proposal with us, we will come up with a deal that is acceptable both to you, the person who owes the money, and the people you owe the money to, and your getting legal protection. That’s the big difference between a consumer proposal and debt settlement.
Ted Michalos: Yeah and what you’ve got to remember is that 99% is our experience rating; different trustees are going to have different experiences. It depends on how many you do. I mean we really are industry leaders in this particular brand of the business.
Doug Hoyes: But no matter what number you’re using and people may be listening and going well I don’t believe that 99% maybe it’s a little less, yeah but we already said that debt settlement according to the Canadian Bankers Association is only accepted 10% of the time. That’s obviously a significant difference.
So, okay we’d like to talk a bit about the legislation so here’s what we’re going to do. We’re going to take a quick break and then we’re going to come back and we’re going to go through the specifics of this new legislation and see why it’s different and then I want your opinion on whether it’s actually going to protect consumers or if this is just yet another government boon doggle. We can talk about that when we come back. You’re listening to Debt Free in 30.
Announcer: You’re listening to Debt Free in 30. Here’s your host, Doug Hoyes.
Doug Hoyes: We’re back on Debt Free in 30. My name’s Doug Hoyes, my guest today is Ted Michalos and we are talking about debt settlement and more specifically the new laws that are coming into effect in Ontario.
We talked in the first segment that the problem with debt settlement companies is that they spend a lot of money on advertising; they feed on the fear that people have about talking to a bankruptcy trustee and convince a lot of people in debt to do a debt settlement. But in the vast majority of cases it doesn’t work. Consumers are being taken advantage of, making large payments to the debt settlement companies with little to no likelihood that their debts would actually be eliminated. So, finally after many years of consultation, I think Ted it’s been like five years or something –
Ted Michalos: At least.
Doug Hoyes: -that this has been in the work, the laws surrounding debt settlement services in Ontario are set to change in an attempt by the government to curb these perceived abuses of the debt settlement industry. So, as of January 1st 2015, so this is already in the past, the Collection Agency’s Act was re-named the Collection and Debt Settlement Services Act. So, what this means it that all collection agents and debt settlement companies are now regulated under the same Act. Kind of bizarre, but that’s the way it is.
Now the change we want to talk about today goes into effect on July 1st 2015. So, if you’re listening to this on the radio, this is not very far in the future. If you’re listening to this on our podcast on iTunes or wherever you listen to your podcast, it may have already happened. But it’s July 1st that all of the provisions of this new legislation become law and the most significant change in the new rules is that debt settlement companies’ fees are capped. So, under the old rules there really were no rules.
Ted Michalos: That’s right, it was the Wild West.
Doug Hoyes: Yeah, charge whatever you want. So, Ted I want you tell me about the new rules. And again I said on the outset we’re not going to start quoting things. If you really want to read it you can go and look up regulation 27 (sub 2, sub 2). Let’s give it to people in layman’s terms. How does it work with the new fee rules for debt settlement?
Ted Michalos: Alright, so the first critical change is that the debt settlement companies are no longer allowed to charge up-front fees. I think there’s a $50 fee that they can levee, but that’s it. So, the old model where they could charge you thousands of dollars and do nothing is gone. Instead they are entitled to 15% of the payments received if you’re doing a plan over a period of time. So, let’s say your settlement is to do $300 a month for the next three years. They would be entitled to take 15% of each one of those payments. Alternatively, they’re allowed to take 10% of the debt for lump sum settlements. So, let’s say you owe big bank $20,000 and they negotiated a settlement for you at $10,000, they’re allowed to charge you a fee of 10% of the 20 or $2,000 and that’s it.
Doug Hoyes: Okay, so, two different types of fees here. And you’re right they can charge a fee of $50 for each outstanding account as a set-up fee. So, if you’ve got five different credit cards, in theory they could charge you $50 for each one of those. That’s kind of minor, who cares? The real thing is that if it’s a series of payments, the maximum they can charge is 15% of each payment. So, if each payment is $100 they can charge an additional $15 on top of that. So, your payment would be $115. And if you’re making a lump sum payment then they can charge 10% of the amount of each debt. So, we were talking the first segment about Fred with his $40,000 worth of debt, so if Fred made a lump sum settlement then the debt settlement fee on that $40,000 debt –
Ted Michalos: Would be $4,000.
Doug Hoyes: Would be 10% of the $40,000, so, $4,000. Okay, so under the new rules there’s no up-front fees, fees can only be charged on payments made to a creditor, which I would assume implies the creditor has to have accepted the deal. And that I guess in the last was really the big problem with debt settlement.
Ted Michalos: Yeah. It used to be that they could present a deal to you, the person that owes the money, collect a fee from you and then try and go and make a deal, if they ever actually try and make the deal. Now they have to make the deal. There has to be an agreement in place and money has to change hands. So, the consumer is much better off than they were under then the old system, because there were no rules under the old system, having said that, I’m still not crazy about this.
Doug Hoyes: Well, okay let’s get into your opinion here. We’ve talked about the facts so I assume you’re a big supporter of the government. You think governments should do more and more in our lives, they’re really the solution to all of our problems.
Ted Michalos: Which government are you talking about now? [laughter]
Doug Hoyes: All governments. I think all governments are fantastic. All the problems in the world are solved by government. So, what do you think the impact of this new law is going to be? Is this going to protect consumers and everything will be wonderful? Like what do you envision in the future?
Ted Michalos: The greatest benefit of this new legislation is that it’s probably driven most of these guys out of business. So, the model they had in the past was charge a fee and then maybe we’ll make a deal. They’re not allowed to do that anymore so they can’t charge the fee until the deal’s in place. Well, they don’t really have any experience in making deals and so I’m hopeful that all of these guys will just disappear or at least most of them, any of them that are trying to operate within the law certainly.
Doug Hoyes: Yeah and the fact is we sit here in June of 2015 recording this. It’s really already started to happen.
Ted Michalos: That’s right. When they announced this legislation a couple of years ago, I mean it drove some of the biggest players out of the market.
Doug Hoyes: And a lot of those big players were actually American based.
Ted Michalos: That’s right. It’s been a funny industry. The U.S has dealt with all of this; they’re probably seven or eight years ahead of where we are in Canada. So, all of these were set up in the U.S, they got pushed out of most of the States. One-by-one they got knocked down so they came to Canada and one-by-one they began getting knocked out of Canadian provinces.
Doug Hoyes: Yeah and I think we should be clear here. We are not either pro or con debt settlement. There are cases where it does make sense. If you’ve got a debt that is reasonably old, but you want to take care of it, if you do have a lump sum, in a consumer proposal we may have to charge X, well it’s possible that that creditor might have accepted slightly less. Now I think we already quoted the stats. Okay, maybe one case of 100 it actually works and we’re certainly not saying that everybody who does this is not reputable. I mean that’s not for us to say.
Ted Michalos: I am willing to say I haven’t met one that’s reputable yet.
Doug Hoyes: Okay.
Ted Michalos: Can I say that? [laughter]
Doug Hoyes: Yeah, we have you on for your opinion. I think we certainly both agree that the big U.S companies that came up here and did this were almost universally despised. I don’t think I can find anyone who would have anything good to say about them. So, your prediction then is that these guys will essentially disappear from the market place?
Ted Michalos: Well, they’re not going to advertise as debt settlement companies anymore. So, now they’re going to morph into debt consultants. And this new piece of legislation has nothing to do with debt consulting. So, debt consulting is, I’m going to give you a plan. I’m going to tell you how to get out of debt and I’m going to charge you a consulting fee for that. That’s where I think this is going to go. So, there’s going to be a transition, some of the language is going to change and people are still going to be taken advantage of, just in a different way.
Doug Hoyes: So, you’ve got some debts, I can’t as a debt settlement person do a debt settlement anymore cause there’s no way for me to charge an up-front fee without knowing whether the creditors going to accept it or not and in most cases they aren’t accepting them. So, that business avenue is gone. So, now what I can do then is charge you a fee to give you advice.
Ted Michalos: That’s exactly right. They’re very – well, as far as I know there’s no legislation regarding consulting in financial matters. Unless you’re selling specific financial products and you’re licensed, so life insurance sales person, real estate agent, RSP or RESP agent, all of those guys have licences. But someone who’s just advocating for debt advice, telling you how to restructure your finances and helping you at your kitchen table, there’s no laws about that.
Doug Hoyes: So, I could start up a company giving debt advice and I could charge $100 an hour or $50 a letter to every creditor and there are no regulations whatsoever surrounding that.
Ted Michalos: Correct.
Doug Hoyes: I can do whatever I want. So, I guess the message then to consumers who are listening is: be very careful when you’re hearing those new ads that will probably start coming up.
Ted Michalos: Anytime somebody says something to you that sounds like it’s too good to be true, do your homework, do your research. I mean trustees, we have the same problem. With a consumer proposal we normally settle for somewhere around 30 cents on the dollar. And because of all these other ads that are out there from debt settlement companies and debt consultants, you don’t know who to believe. So, find out are you actually talking to a licensed trustee? Is this company registered with the Better Business Bureau? I mean there are ways because of the internet that you could look into people’s backgrounds and the experience other folks have had with them. Make sure you’re dealing with somebody reputable.
Doug Hoyes: And if it sounds too good to be true it probably is.
Ted Michalos: It probably is.
Doug Hoyes: And so your prediction is we may not see the debt settlement per se advertisements in the future but we’re going to start seeing a different type of advertisement. Here we can help you, we can coach you, we have this program that will write the letters for you. They can’t talk directly to the creditors, so it will be we’ll show you how to do it and we’ll make everything fine.
Ted Michalos: Yeah you hit on the magic word. I think we’re going to see a lot of people say debt coaches. Coach, coach, coach, we’re going to help you; we’re going to show you how to do it. We’re not actually going to do it.
Doug Hoyes: And again we’re not trashing debt coaches, I mean in fact we’ve had the guy from Debt Coach Canada, Eric Putman, on this show and I’ve certainly never heard any complaints about him. We’ve known him for many years, he’s a reputable guy, but he’s not coaching you on how to make debt settlements, he’s coaching you on how to manage your finances, that’s a totally different thing.
Okay, so it will be interesting to see how this all pans out. That’s some very good advice on the new debt settlement rules that come into effect July 1st, 2015 in Ontario. Ted, thanks very much for being here.
Announcer: You’re listening to Debt Free in 30 with Doug Hoyes. We’ll be right back.
Doug Hoyes: It’s time for the Let’s Get Started segment here on Debt Free in 30. I’m Doug Hoyes. My guest today is Ted Michalos and we’ve been talking about debt settlement. There are new laws that come into effect July 1st 2015 in Ontario. And Ted, the quick summary of those new laws is what?
Ted Michalos: No up-front fees, the settlement company can only charge a fee based on the terms of the agreement. So, they can collect 15% of a monthly payment if you’re doing a period of payments over time or they can collect 10% of the debt as a fee if you’re doing a lump sum settlement. The biggie, they can’t take any money up-front.
Doug Hoyes: No up-front fees and this is a big change from the past when any fees, anything goes, it was all good. So, what is your opinion then, and I asked you a bit about this in the show and we kind of got sidetracked, is this a good law? Is this going to help consumers or are there still some underlying flaws that mean this is much ado about nothing?
Ted Michalos: So, this is a good first step because it immediately caused a number of people who I think were less than reputable, to rethink their whole business model. They couldn’t charge fees up-front, so it was time for them to get out of the business. I think those folks are going to come back. They’re going to morph into things called debt consultants or perhaps debt coaches; that was an excellent word you came up with. And so we’re going to have a repeat of all the problems we had with debt settlements with these new debt consultants in the next couple of years.
So, the government’s going to have to come along and figure out what to do about them. And the underlying problem is that because these folks aren’t licensed and legislated properly, consumers are still going to be taken advantage of. And it’s not because consumers are stupid, it’s because people don’t know what their rights are under the law.
So, as a licensed trustee, I’ve got to tell you this is how the law works, this is what I can do for you, this is the protection I can provide. A debt consultant doesn’t have to do any of that so people are still going to fall prey to folks just looking for solutions.
Doug Hoyes: If I’ve got a medical problem, if I’ve got a sore tooth and I go to a dentist, I at least know that if you’re a dentist operating in this country there are certain minimum standards that require you to operate. Anybody just can’t call them self a dentist, but anyone can call them self a debt consultant, but anyone can’t call themselves a consumer proposal administrator.
Ted Michalos: Correct.
Doug Hoyes: You have to be licensed by the Federal government and obviously there’s a significant educational requirement to do that. So, when we compare the two options – a consumer proposal or a debt settlement – we said that a debt settlement in most cases doesn’t actually work.
Ted Michalos: Yeah, I mean the success rate is dismal.
Doug Hoyes: The success rate is dismal. With a consumer proposal, as soon as the proposal is filed on day one you get protection from your creditors. I assume that’s a huge advantage then as to why a consumer proposal is a better option.
Ted Michalos: I mean if the whole reason that you went to the debt settlement guy or the debt consultant guy in the first place was you were afraid of having your wages garnisheed or your bank account frozen, you’re missing payments on your truck or house and you’re afraid of repossession, well a debt consultant can’t provide you with any legal protection. So, under the Bankruptcy and Insolvency Act you file a consumer proposal you get an automatic stay of proceedings, which means no legal actions can continue, or be commenced against you, until we figure out what’s happening with the proposal.
Doug Hoyes: I guess as well with a proposal there is – all the creditors know that there is a next step. If they don’t accept the proposal what is likely to be the debtors only other option?
Ted Michalos: In the majority of cases if something is rejected then the debtor’s going to turn around and file a personal bankruptcy. I mean the proposal’s designed as an alternative to filing bankruptcy.
Doug Hoyes: And that’s why the success rate on consumer proposal is so high; if the creditors know they’re going to get more money in a consumer proposal than they’re going to get in a bankruptcy, and the person who owes the money is filing the consumer proposal because they want to avoid bankruptcy, they want to pay back at least a portion of their debts. So, there’s that inherent leverage there in there, with a debt settlement, well if the debt settlement company says no – or sorry, if the bank says no – well then what?
Ted Michalos: Well and you know the vast majority of cases, at least in the past, no deal was put into place. So, the creditors were left hanging, they didn’t even know there was a settlement coming and so they initiated legal options. So, they started a law suit, they wanted to garnishee wages. Well, so now the settlement can’t work anyway so the consumers were forced either into a proposal or often times bankruptcy cause they were just so scared of what had happened to them.
Doug Hoyes: And at least with a legislated solution like a consumer proposal or a bankruptcy, everyone knows the steps, everyone knows what’s required. In a consumer proposal how quickly are the creditors notified that a proposal’s been filed?
Ted Michalos: So, they’re required to receive notice within five business days. So, weekends don’t count on this. But, the majority of the trustees in Canada now are using electronic systems so the creditors get notified much more quickly. A couple of days.
Doug Hoyes: So, literally if you’re filing your proposal on a Monday but Tuesday it’s probably in their hands, they know right away, which was a big difference with debt settlement in the past.
Ted Michalos: Well and it’s mute because the legal protection starts as soon as you sign, not when the creditors receive the notice. So, when you’re looking for protection, you’re afraid of a wage garnishee or a law suit, the proposal starts as soon as you sign the documents.
Doug Hoyes: And that’s really the whole key to it. So, then your advice then in our last 20 seconds is, given a choice, the proposal is going to be the better option in virtually in every case.
Ted Michalos: It is. I want you to look into all your options but quite frankly I’d be surprised if you pick something different. Because the laws are designed to protect you and to provide – there’s a distinct advantage to a proposal over just about any other solution.
Doug Hoyes: Legal protection and it’s a better deal, it’s as simple as that. Great, thanks very much for being here Ted. That was the Let’s Get Started segment here on Debt Free in 30.
Ted Michalos: You’re listening to Debt Free in 30. Here’s your host Doug Hoyes.
Doug Hoyes: Welcome back, it’s time for the 30 second recap of what we discussed today.
On today’s show Ted Michalos explained that under new laws that take effect in Ontario on July 1st, 2015, debt settlement companies will be prevented from charging up-front fees and their fees will be capped, which is designed to help consumers. That’s the 30 second recap of what we discussed today.
So, what’s my take on the new rules? As, you’ve probably guessed from our comments on the show, I’m not a big believer in government being the solution to all of our problems. Well, it’s true that that the new rules will drastically alter or eliminate the old debt settlement company model, there are a lot of people with debt and it’s too big a market to ignore. So, I agree with Ted’s prediction, it’s likely that some new industry will spring up to try and separate consumers from their money.
Don’t be fooled, there are no quick fixes. You can’t just pay some telemarketer a bunch of money to make your debts go away. You either need to cut your expenses and work through it on your own or if your debts are too big to handle, you need to get help from a competent experienced licensed professional.
That’s our show for today. Full show notes are available on our website including details on why a consumer proposal is almost always a vastly better solution than a debt settlement plan. So, please go to our website at hoyes.com, that’s h-o-y-e-s-dot-com, for more information.
Thanks for listening. Until next week, I’m Doug Hoyes. That was Debt Free in 30.
Ontario has implemented new debt settlement laws to protection consumers against unscrupulous debt settlement practices. You’ve seen the ads. Debt settlement companies promise to “reduce your debts by 70%”. They say “don’t talk to a trustee about bankruptcy or a consumer proposal; talk to a debt settlement company instead!” They offer to settle your debt for less than the full amount owing in exchange for which, up until now, they charged a rather large up-front fee.
Unfortunately, according to the Canadian Bankers Association “only about 10 percent of proposals that banks receive from debt settlement companies are actually accepted”.
That’s the problem. Debt settlement companies spend a lot of money on advertising, feed on the fear people have about talking to a bankruptcy trustee, and they convince a lot of people in debt to choose debt settlement but, in the vast majority of cases, it doesn’t work. Consumers are being taken advantage of, making large payments to the debt settlement companies with little to no likelihood that their debts would be eliminated.
Finally, after many years of consultation, the laws surrounding debt settlement services in Ontario are set to change in an attempt to curb the perceived abuses of the debt settlement industry.
What does the new legislation look like?
As of January 1, 2015 the Collection Agencies Act was renamed the Collection and Debt Settlement Services Act. What this means is that all collection agents and debt settlement companies are now regulated under the same Act.
On July 1, 2015 all of the provisions of the new legislation become law. The most significant change in the new rules is that debt settlement company fees are capped.
If the debtor is making a series of payments to a debt settlement company, the debt settlement company can charge a maximum of 15% of each payment (Regulation 27 (2)(ii)) plus a one-time set up fee of $50 per outstanding account.
If the debtor will be making a one-time lump sum payment, the maximum fee is 10% of the amount of each debt (Regulation 27 (3) (ii)).
Here’s an example of how high fees could be charged for debt settlement services when there are no regulations:
Joe has $40,000 in debt, and was paying $500 per month to a debt settlement company. The debt settlement company charged him a $2,000 up-front fee, plus 20% on a $10,000 settlement. Unfortunately for Joe, after four months one of his creditors took him to court so Joe stopped making the payments to the debt settlement company. Joe paid $2,000 in fees for nothing.
Under the new rules:
There are no up-front fees. Fees can only be charged on payments made to a creditor, which implies that the creditor has accepted the deal;
If Joe made a lump sum payment of $10,000, the maximum fee would be 10% of the total debt, or $4,000, but only after the creditor has accepted the deal;
If Joe made a series of payments, the maximum fee would be 15% of every payment made. So if Joe pays a total of $10,000, the maximum fee would be $1,500.
The second most important change to the new debt settlement laws is that all companies offering debt settlement services must be licensed under the Collection and Debt Settlement Services Act.
How will new fee regulations impact the debt settlement industry?
Under the old rules, debt settlements were very profitable because the debt settlement company was paid up-front. Even if the creditors did not accept the deal (and most of the time they didn’t), the debt settlement company kept the first three or four months’ worth of payments. It was a great business. Collect money for four months, do nothing, don’t contact the creditors, and when the debtor got sued for non-payment, just say “oh well, sorry” and that was that. Free money.
Under the new rules, there are no up-front fees. The debt settlement company will have to negotiate a settlement with the creditor before they can charge any fees. Since most creditors will not accept a deal from a debt settlement company, they won’t be able to charge any fees.
Regulation 28 (1) says that a debt settlement company may not accept any payment from the debtor until the debtor and creditor have made a settlement, and the debtor makes the first payment.
That effectively puts most debt settlement companies out of business, which I assume is exactly the government’s intention.
How will the new rules impact credit counsellors?
Regulation 19.1 specifically exempts from these rules a “not-for-profit corporation that is a registered charity as defined in the Income Tax Act (Canada) and that provides credit counselling services”. As long as credit counsellors are operating as charitable organizations, they may continue to help debtors settle their debts.
In the past, not-for-profit credit counsellors did not administer debt settlements. They administer debt management plans where the debtor pays back the full amount owing, but with little or no interest. There is nothing to prevent not-for-profit credit counsellors from continuing to offer debt management plans.
Will they start to offer debt settlement plans? Perhaps, since they are not prevented from doing so under the new rules, but that’s unlikely since it’s not their primary business. More importantly, the fee structure under the new rules may not necessarily be as beneficial to the credit counselling agency themselves.
Today, the typical credit counselling agency charges a fee of 10% of the monthly payment made by the individual entering into a debt management program with a credit counsellor. Under the new Collection and Debt Settlement Services Act they could charge up to 15% of each payment. However, credit counselling companies also receive a fair share donation back from some creditors who participate in a debt management program. The amount will range from 0% to 22% depending on the creditor. Not all creditors participate, but most of the major banks (those we owe significant credit card debts to) do pay credit counselling agencies to administer debt management plans. So on average, credit counselling agencies are likely making at least 15%, if not more, on most debt management plans already. In instances where they make a debt settlement (for less than the full amount owing) the banks are unlikely to continue to contribute a portion of their recovery to the not-for-profit credit counselling agencies.
Credit counselling agencies rely on this funding in order to provide additional counselling services and information, for free, to individuals seeking advice on how to budget and manage money. Moving into the world of debt settlement could put this funding at risk.
How will the new rules impact bankruptcy trustees?
Bankruptcy trustees are already regulated by the federal government (the Office of the Superintendent of Bankruptcy). Trustees are not permitted to charge up-front fees (trustees begin collecting funds when the proposal or bankruptcy is officially filed). Trustees’ fees are strictly regulated by the government; so because trustees are already regulated, and do not offer debt settlement services, these rules will have no impact on federally licensed trustees.
The Bankruptcy & Insolvency Act already provides for a legal debt settlement mechanism through a proceeding called a consumer proposal. Given that there is no need for trustees to offer informal debt settlement services outside of the Act.
How will the new rules impact collection agencies?
The new Collection and Debt Settlement Services Act regulates both debt settlement companies and collection agents, so it is now theoretically possible that a collection agent could offer debt settlement services.
For example, if a collection agent calls you to collect for Company A, and you say to the collection agent “I can’t pay because of all of the other debts I have”, the collection agent could say “okay, pay what you owe to Company A, and I’ll help you work out a debt settlement with the other companies”.
The concern with that possibility is that collection agencies, if they are offering debt settlement services to the debtor have a perceived, if not clear, conflict of interest. They will want to collect as much as possible for themselves and the creditor who contracted them to collect on the debt. At the same time they would be working for the debtor to negotiate a debt settlement. In a consumer proposal, a trustee is neither working for the creditor nor the debtor. The trustee’s role is defined by the Bankruptcy & Insolvency Act and if either party has a concern, resolution to the issue can be addressed through the bankruptcy court. No such provision is readily available under the new Ontario regulations surrounding debt settlement services.
Will collection agencies offer debt settlement services? I have no idea, but under the new rules it is possible, so we will continue to monitor the implementation of the new rules to determine how they are impacting consumers in Ontario.
The underlying flaws remain
Even with these legislative changes, debtors are still taking significant risks in the debt settlement process. I’ll start off by admitting my bias as a bankruptcy trustee. However, I believe that, in almost all cases, a consumer proposal is still a better option for most people who owe more debt than they can repay and want to offer a settlement proposal to their creditors.
Even in a consumer proposal, creditors can, and do, ask for a higher settlement. However, through the consumer proposal process, the debtor has the benefit of an automatic stay of proceedings while negotiations take place. A “stay of proceedings” means that between the time that the consumer proposal is filed and when the voting occurs, creditors are not permitted to take any collection action, and may not continue legal proceedings or garnishee wages. This protection is not available in an informal debt settlement. Creditors can still send accounts to collections, sue or garnishee wages. This gives them significant power during the negotiating process in a debt settlement, and puts the debtor at a significant disadvantage, which is one reason I believe that a consumer proposal is almost always a better option.
A debtor working with a trustee has the strong leverage of the possibility of filing bankruptcy. Because a consumer proposal deals with all unsecured creditors (another advantage over debt settlement), settlement amounts are in large part based on what these creditors would receive if the debtor were to declare bankruptcy. Deal with just a few creditors through an informal debt settlement and no such ‘valuation’ exists. Large creditors will demand whatever they can, creating an imbalance between the debtor and the creditor, as well as between large and small creditors.
As mentioned earlier, there are no checks and balances to ensure that all parties are treated fairly and with due process in a debt settlement. While debt settlement providers must be licensed under the Collection and Debt Settlement Services Act, there are no provisions to ensure that those offering these debt settlement services will be properly trained and educated, follow rigid rules of conduct, and treat all participants fairly. It will still be relatively easy to hang out a shingle as a ‘non-profit’ credit counsellor. The same applies to representatives of the myriad of collection agencies in Ontario. The individual on the end of the phone is typically an employee at a call center with little to no training in debt management. It is unlikely that they will be able to explain to the consumer the full pros and cons of any settlement offer they are proposing, and in most cases, they will be unable to provide information about alternatives.
It’s still a case of caveat emptor
Here’s the point: the new debt settlement regulations, while an improvement over the current “anything goes” legislative approach, may not truly be able to protect the average indebted consumer from predatory debt settlement practices. It may limit fees, but it will not guarantee that the individuals receive helpful advice and an end to their debt problems.
If you have more debt than you can handle, even a new lower fee debt settlement plan is not the answer. Speak to a federally regulated, licensed, experienced consumer proposal administrator who can offer a legally binding settlement to all of your creditors, and use the power of federal law to eliminate your debt.
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