There are several options available for dealing with your debts in Ontario, but today I want to discuss bankruptcy versus credit counselling.
There could not be two debt relief programs viewed more differently by consumers. Bankruptcy is considered to be the worst possible thing you could do for your finances, while credit counselling is seen as unbiased, free, and harmless. Neither extreme is accurate.
To help you decide, I’ll explain how bankruptcy and credit counselling work, compare their true costs and requirements, so you can pick the best option for you.
Table of Contents
How bankruptcy and credit counselling work
What are bankruptcy and credit counselling?
Bankruptcy is a legal process to eliminate overwhelming debt. Its primary benefit is the complete removal of your existing unsecured debts (but excluding secured debts like your mortgage or car loan). Personal bankruptcy provides debt relief by completely discharging you from your obligation for debt repayment.
Credit counselling, on the other hand, is generally considered as a service that provides debtor assistance and teaches and guides people towards better money and debt management skills. People view a credit counsellor as someone who provides financial education and tools to manage their finances successfully. While some credit counselling agencies still do this kind of traditional counselling, today credit counselling is more about the enrollment in a debt management plan which is a program to pay back debts through a credit counsellor over a period of time.
How does bankruptcy work?
If you want to file for bankruptcy, you must set up a meeting with a Licensed Insolvency Trustee who will complete a debt assessment for you. During the debt assessment, the trustee will ask you a series of questions, including who you owe money to, how much money you owe, what your salary is and what type of assets you have.
If you are unable to pay your debts as they become due, you are insolvent, which means you are eligible to file bankruptcy.
A debt assessment is really about ensuring that personal bankruptcy is the right solution for you. As a Licensed Insolvency Trustee, I am obligated by law not only to explain bankruptcy but to provide you with information on all your options, including credit counselling.
What bankruptcy does, that credit counselling does not, is provide creditor protection. After you file, your trustee will notify your creditor that you have gone bankrupt, resulting in a ‘stay of proceedings’ against your unsecured creditors. This stay:
- Puts a halt to collection agencies calling or suing you
- Can stop a wage garnishment
- Means you can legally stop paying your unsecured creditors going forward
Bankruptcy equates to a fresh financial start, but your trustee will still only recommend this as an option of last resort.
How does credit counselling work?
Chatting with a credit counsellor begins with a financial assessment where they look at your income, expenses, and debts to see if you can afford to repay your debts in full. To qualify for a debt management plan (DMP), you do not have to be insolvent, but you must be able to pay back your debts in full within five years.
When you opt for a DMP, you can consolidate your unsecured debt, including past due utility bills, unsecured loans, and credit card debts, into one monthly payment to the credit counselling company.
By repaying your debts through a credit counselling agency, you permit them to:
- Talk with your creditors on your behalf
- Consolidate your debts into a monthly repayment
- Charge a 10-15% fee for their work
- Deal with any collection calls and ask if the creditor wants to participate in the plan.
Credit counsellors don’t talk with your creditors until you sign the paperwork to do a DMP. Once that’s done, your counsellor will contact any creditors you decide to include in your plan, for example, your credit card company, your cell phone provider and bank.
Each creditor is in control of whether they agree to the plan, and it’s essential to understand that they don’t have to participate or agree to freeze or lower interest charges.
Unlike in a bankruptcy, if a creditor does not agree to work through the credit counselling agency, you must continue to make debt payments to that creditor. There is no stay of proceedings. If you don’t continue to pay creditors who do not participate in the program, they can send your account to collections and commence legal action against you to recover the debt.
Credit counselling also won’t stop a wage garnishment unless the creditor voluntarily agrees to revoke the order, which is highly unlikely if you are at that stage of collection.
How to determine whether bankruptcy or credit counselling is the right option for you
There are some key things to compare when deciding between personal bankruptcy or credit counselling such as eligibility, cost and effects to your credit score.
When is bankruptcy a good choice?
Bankruptcy is best worth exploring when you carry several thousand dollars in consumer debt, such as high-interest installment loans, credit card debt, lines of credit, tax debt and student loans. If you only have very small debts, then bankruptcy is likely not for you.
Bankruptcy is also an effective way to get help with payday loans. Payday lenders may not agree to participate in credit counselling, or if you owe more than one payday lender, it may be better to wipe the slate clean through bankruptcy.
When is credit counselling a good choice?
Consolidating debts over bankruptcy works if you have smaller, more manageable debts and this is where credit counselling can help.
And that’s the key. Credit counselling is only a good choice if you can afford the monthly payment required to pay back all of your debt. Credit counselling is a good idea for a couple of overdue bills and an averagely sized credit card balance.
Higher debt balances can equate to unaffordable monthly payments. Because people view credit counselling as better than bankruptcy without thoroughly investigating the differences. It’s not unusual for us to meet with someone in our office in the middle of a failed debt management plan they can no longer afford. Unfortunately, they’ve now discovered that they’ve wasted both time and money partially repaying debts that they could have eliminated through bankruptcy (or a consumer proposal) much cheaper and much sooner.
Furthermore, some debts simply cannot be included in a debt management plan, such as student loan debt, tax debts and some payday loan companies, so it’s best to look to bankruptcy or a consumer proposal for these.
What costs are involved in bankruptcy and credit counselling?
Neither bankruptcy nor credit counselling, are free.
The cost of bankruptcy is determined by your income, expenses, family size and assets and differs from person to person.
The minimum cost to file for bankruptcy is $1,800, payable in 9 monthly installments of $200. If you have no assets and earn below a set government income threshold, that’s all you’ll pay no matter how much you owe. Remember, once you file bankruptcy, you stop paying your creditors.
Credit counsellors usually charge a fee of 10% – 15% of your debts; however, you must also repay your debts, which makes the true cost of credit counselling much less affordable over time.
That’s why we say debts below $10,000 are generally better suited to credit counselling, and for debts above that amount you should talk with a Licensed Insolvency Trustee. Without a substantial income or room in your budget, it’s challenging to repay debts greater than $20,000 through credit counselling.
How do bankruptcy and credit counselling affect your credit score?
A common bankruptcy myth is that filing for bankruptcy will completely destroy your credit score, and you will never be able to borrow money again. But this isn’t true.
Bankruptcy remains on your credit report for 6-7 years after your discharge, and you often can get a credit card while bankrupt– just make sure to upkeep with payments so you can rebuild your credit score and NOT add to your debt.
In comparison, it’s a popular myth that credit counselling doesn’t affect your credit score. But this isn’t true. Any debt relief program will affect your credit.
If you file for a debt management plan, it will be stated on your credit report as an R7, like any other debt remediation program, including a consumer proposal. Depending on the credit bureau, it will remain for a maximum of 6 years from the date you began the program. So while credit counselling can sometimes be cleared from your report faster than bankruptcy, it has the same impact as a consumer proposal, which is a debt relief solution also available through a Licensed Insolvency Trustee.
The correct choice is one that offers the best path to financial recovery. If you are struggling with a lot of debt, bankruptcy is often the faster way to improve your financial situation because you can eliminate your debt much sooner. With fewer debt payments, you can begin to set aside savings, balance your budget, stop living on credit, and this can go a long way to helping you re-establish both your finances and your credit.
Alternatives to bankruptcy and credit counselling
You might have read this far through and decided that neither bankruptcy nor credit counselling is the option for you, and if that’s the case, don’t worry. There are alternatives to bankruptcy and credit counselling available such as:
- Consumer Proposal – This is an alternative procedure available through a Licensed Insolvency Trustee that provides the same legal benefits as claiming bankruptcy. And, you only repay a percentage of what you owe to creditors. This option is often better and cheaper than credit counselling, and creditors are unable to take legal action against you while you are in a consumer proposal, which is protection that doesn’t exist in a debt management plan.
- Debt Repayment Plan or budgeting– You can pay off your own debt by creating a debt repayment plan, complete with a final deadline with the right personal debt reduction strategy. However, for paying back debts on your own to be viable, you must have both discipline and a workable household budget.
- Debt Consolidation Loan – A debt consolidation loan is a more manageable way to repay your debts by lowering the interest rate on high-interest debt. You need to apply and qualify for it, but essentially it is a loan that is issued to pay off multiple small loans.
- Debt Settlement Plan – If you only have a small old debt, you could try to negotiate with your creditor or debt collector on your own. Another option is to work with a fee-for-service debt settlement company, but we do not recommend this as many charge high fees to refer you to a licensed insolvency trustee for a consumer proposal anyway.
How to get legal help with personal bankruptcy or credit counselling
I know it can be challenging to make a decision on how to get out of debt, but making the right choice begins with who to speak to about these two debt relief options – a credit counsellor or licensed insolvency trustee.
Credit counselling is more suited for smaller, affordable debts that you know you can pay in full.
If you have more massive debts that you cannot meet payments for, then bankruptcy could be the best option. However, even bankruptcy is not your only legal option. It’s worth considering a consumer proposal because it could cost less.
That’s why it’s often better to speak with a Licensed Insolvency Trustee directly. A Licensed Insolvency Trustee is the only debt relief professional in Canada legally allowed to administer insolvency procedures regulated under the Bankruptcy and Insolvency Act (BIA).
Licensed Insolvency Trustees are licensed to file, manage and supervise bankruptcies and consumer proposals as well as guide the debtor through the entire process, dealing directly with the creditors on their behalf.
A Licensed Insolvency Trustee can also recommend an accredited counsellor if this is the right choice for you, so you avoid dealing with unlicensed agencies.
You don’t have to do this on your own! We can help you to determine if bankruptcy is the right solution, or if possibly credit counselling or a consumer proposal could be more fitting.
At Hoyes, Michalos & Associates, we are confident that we can help you resolve your debt in the best way because:
- We will explain all of your debt relief options
- We will find you a solution you can afford
- We provide as many consultations as you need, for free
Book a consultation with a Licensed Insolvency Trustee at Hoyes, Michalos & Associates today!