When debt and unpaid bills become a problem, you may be trying to decide whether you should file bankruptcy to eliminate your debt or repay your debts through a debt management plan.
The answer is something we review with every client as part of the consultation process. To help you decide which debt solution may make more sense for you, I’m going to walk you through the types of questions and information we would address as part of an initial debt assessment.
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The difference between debt management and bankruptcy
A debt management plan (DMP) is available through a credit counselling agency. The credit counsellor’s role is to review your budget and help you create a repayment plan to pay back your debt. They will arrange for you to make monthly payments to the credit counselling agency, instead of your creditors, until the debt is paid in full. A credit counsellor may be able to negotiate future interest reduction, but they cannot lower the principal amount you have to repay.
Bankruptcy is a legal process that wipes out almost all your debt, with some exceptions, so that you get a fresh start. Bankruptcies are filed through a Licensed Insolvency Trustee whose role is to explain your debt relief alternatives, including a debt management plan or consumer proposal. If you choose to file an insolvency proceeding, your LIT will administer the bankruptcy process.
In the middle of these two options is a consumer proposal. Like a debt management plan, a consumer proposal allows you to make payments over time (up to five years), but, like bankruptcy, a consumer proposal is a debt settlement option that can reduce the principal amount you have to repay.
Now that we understand the broad differences in how these debt relief alternatives work let’s review what facts from your situation could help you determine which option is best for you.
Can you afford to repay your debts in full?
It’s always better to pay off your debt in full if you can reasonably afford to do so. If you owe a small amount of debt and need help balancing your budget or structuring your payments, then a debt management plan is a good option.
If, however, you are barely keeping up with your minimum payments and are looking at years to repay your credit card debt, or are trapped in a payday loan cycle, then you may need more relief.
You must be insolvent to be eligible to file bankruptcy. You are insolvent when you cannot repay your debts as they come due.
If you need debt forgiveness, a bankruptcy or consumer proposal is better than a debt management plan.
In making this decision, you need to ensure you can maintain the monthly payment for the duration of the program. It is not uncommon for us to have someone contact our office after entering into a debt management plan, only to find out they can no longer afford the payments. The result is wasted time and money for the debtor.
Do you need creditor protection?
Filing bankruptcy provides a legal stay of proceedings, something a debt management plan can’t do. This legal stay means that your unsecured creditors are prohibited from pursuing you any further to collect.
The benefits of this automatic stay mean that:
- all collection calls stop
- wage garnishments stop
- court proceedings, lawsuits and legal actions cease as well.
A bankruptcy forces all unsecured creditors to stop collection activity. With a debt management plan, creditors can agree to stop calling and participate in the program, but that agreement is voluntary. A debt management plan can’t guarantee protection from legal action, but a bankruptcy can.
Do you have debts that can’t be included in a debt management plan?
A debt management plan is generally suited to credit card debts, unsecured bank loans and unpaid bills like outstanding utility accounts that have not yet been sold to a debt collector.
A debt management plan cannot deal with:
- tax debts
- student loan debt
- some payday lenders will not participate
- complicated legal debts
Bankruptcy can eliminate all unsecured debt with a few exceptions. Since the Bankruptcy & Insolvency Act is federal legislation, it does bind the federal government, which means that tax debts can be included. Canada (and provincial) student loans can be discharged by bankruptcy if you have been out of school for seven years.
Neither bankruptcy nor a debt management plan can eliminate your obligation to pay alimony or child support, legal fines or debts due to fraud.
Secured debts, like your mortgage or a car loan, are also excluded from both a bankruptcy and debt management program. Neither option can prevent a secured creditor from taking possession of assets used as collateral for a loan if you are behind on your payments.
Do you have too much debt for a debt management plan to work?
Theoretically, you can consolidate as much debt with a debt management plan as you can afford to repay.
Remember, a debt management plan requires that you repay 100% of what you owe, plus 10% in DMP fees. The larger your debts, the higher your payment with a debt management plan.
The cost of bankruptcy is not based on how much you owe. Bankruptcy cost is based on how much you make and any non-exempt assets that must be sold to benefit your creditors. Bankruptcy is almost always less costly than a debt management plan, but the cost-benefit is even greater the more you owe.
Your credit score impact is not a deciding factor
Both a debt management plan and bankruptcy are reported to the credit bureaus. Both will hurt your credit report at the start. Bankruptcy is coded as an R9, which is considered worse than a debt management plan at an R7. However, a consumer proposal is also coded as an R7, the same as a debt management plan.
The credit impact of a debt management plan versus bankruptcy should not be a deciding factor.
When choosing between a bankruptcy and a DMP, financial facts are the most important criteria:
- Can you afford the payments?
- Do you need creditor protection?
- Will you be able to eliminate your debts through a DMP?
The key is to eliminate your debt so that you can rebuild.
Whether you should file bankruptcy to erase debt or enter into a debt management plan to repay debt is dependant on your unique situation. Informed decisions have the best outcomes. Book a free consultation with a Licensed Insolvency Trustee for debt advice to help you choose.