All forms of debt settlement appear on your credit report in the same way. They are listed as an R7 to show that you have entered into some form of settlement agreement for the debt. This agreement might be a debt settlement plan, a credit counselling plan or a consumer proposal. That means that initially, all debt settlement programs affect your credit rating the same way.
We review which option can help you start the recovery process sooner (spoiler alert the answer might surprise you), but to start let’s take a look at the three most common debt settlement programs available in Canada.
Informal Debt Settlement: The least likely to work and the most risky
Informal debt settlement plans offered through unlicensed debt coaches or debt consultants are not regulated and may be administered by anyone willing to set up such a company. Recently, Ontario has taken steps through the Collection and Debt Settlement Services Act to ban such companies from charging their fees “up-front” before they actually settle your debts. Since most informal debt settlement options don’t work, that effective put a stop to this type of program. However, some companies have switched their business model, selling consumer proposals (even if they don’t call them that) and charging the debtor a fee for advice then sending them to a licensed insolvency trustee any.
Credit Counselling Plans: Pooling debts and managing payments
Credit counselling agencies offer a program called a debt management plan. These are administered by not-for-profit agencies. The plan pools your debts together, eliminates any new interest and you repay your debts in full over 48 months. If you have the ability to repay 100% of your debt then you should consider credit counselling as a viable option.
Consumer Proposal: Legal debt settlement through a licensed trustee
A consumer proposal is a legal procedure whereby you repay a portion of what you owe over a maximum of five years. Most proposals require you to repay about one third of what you owe.
Only licensed insolvency trustees (the new designation for bankruptcy trustees in Canada) may administer a consumer proposal, so before you sign any agreements to pay, make certain you are dealing directly with a licensed trustee and not a debt consultant that will pocket your money and refer you elsewhere.
Which debt settlement option will allow you to rebuild your credit report the quickest?
The answer, surprisingly, is to file for bankruptcy. Of the options discussed, bankruptcy has the shortest duration. Most bankruptcies run either 9 or 21 months. Differently, credit counselling runs 48 months and consumer proposals can last up to 60 months.
To put this into perspective, if after you complete your bankruptcy you start saving your bankruptcy payment, by the time you will have completed your credit counselling plan you will have 27 months worth of payments saved up. By the time you will have completed your consumer proposal, you will have 39 months worth of payments saved. These savings will give you better access to new credit than any other thing you can do (high income will really help, but most of us can’t control that).
If rebuilding your credit is your highest priority, then you should be filing an assignment in bankruptcy to deal with your debts.
When considering your debt relief options, getting out of debt should be your priority, and only after you have completed this goal, should you focus on rebuilding your credit score. You should consider which option will allow you to eliminate your debt for the lowest cost. For some individuals that does mean filing bankruptcy particularly if you have no assets and a lower income. If however your income is above the surplus income threshold, or you have assets that you might lose in a bankruptcy, then a consumer proposal may be a better choice. Here you are weighing the advantages of spreading the cost of your insolvency over a period of time (lowering your monthly payments) and preserving assets you might want to keep against the quicker alternative of a bankruptcy. A lower monthly payment through a consumer proposal can help you balance your monthly budget so that you are able to rebuild your finances even while you are still in the program. Many people find they are able to start to save money while in a consumer proposal because their monthly payments are significantly less than they where on their debts before they filed.
The key is to focus on the future rather than the past. Decide where you want to be, not on where you’ve already been, and choose the best way to get there.