It’s important to know the difference between debt problems and creeping insolvency. Knowing how serious your situation is will help you choose the right option to deal with your debt.
Sometimes it’s easy to tell if you have debt that is just simply beyond repayment. You are behind on your bill payments, you borrow from one credit card to pay off another or you visit multiple payday loan lenders because debt has gotten out of hand. These are some obvious signs that you are insolvent and may need to file a consumer proposal or bankruptcy to eliminate your debts and get a fresh start.
For others the signs that they are in deep debt trouble, that they are insolvent, are not as obvious. We meet with many people every day who say ‘I’m keeping up with my payments’ or “My credit score is pretty good still’ yet filing insolvency is still something they need to do.
So how do you know if you are insolvent? How do you know if you need to file insolvency to deal with your debt?
There are two definitions of insolvency or the state of being insolvent.
To be insolvent means that:
- the amount of your total debts is more than the value of your total assets or
- you are unable to pay your debts as they become due because of poor income or cash flow.
You’ve got debt problems and wonder if they’re bad enough to consider something like filing bankruptcy or a consumer proposal. I’m Doug Hoyes, a Licensed Insolvency Trustee with Hoyes, Michalos & Associates. I meet with people every day who are struggling with debt yet most don’t need to go bankrupt, they are not insolvent. Today we’re going to explore what it means to be insolvent.
To file a bankruptcy or a consumer proposal in Canada you must, by law, be insolvent. For most people this means they can’t pay their debts, as they become due, you are cash-flow insolvent. Basically, you don’t have enough money each month to pay your rent and living costs, plus make all of your debt payments. There are three common warning signs to tell you that you may be cash-flow insolvent.
Number one, your debt increases each month. This happens if you’re using debt to pay for everyday expenses, or you’re using a cash advance on one credit card to pay off another.
Number two, you’re only making the minimum payments on all of your debts. You might think you’re OK because you never miss a payment, but if you only pay the interest on high-interest debt, your balances will never go down.
And number three warning sign, your credit cards are maxed out and you have, or are thinking about a high-cost finance company loan or payday loan just to keep up, that’s cash-flow insolvent.
The second definition of insolvent is asset insolvent. Asset insolvent means you owe more than you own. If you add up the liquidation or resale value of all the assets you own, your car, your house and any savings you might have, and subtract the total of everything you owe, and the number is negative, well you’re in the hole. You don’t have enough stuff to sell or cash in to repay your debts, that’s asset insolvent.
Most people I meet with are cash-flow insolvent. So if you don’t have enough cash flow to repay your debts do you need to file bankruptcy; maybe, maybe not. If you have extra asset value like some equity in your home, you might be able to either sell your home or borrow against it with a home equity consolidation loan. You use your extra asset value to get a home equity loan to pay off your high-interest rate debts, like credit cards, to lower your monthly debt payments enough to balance your budget and eventually pay off your debts on your own.
If you have a decent income but too much debt to pay off on your own or through refinancing, you might be able to offer a consumer proposal to your creditors. In a consumer proposal we make a deal with the people you owe money to where we say, “Hey, I’m insolvent. I don’t have enough assets to sell to repay you and I don’t earn enough to pay you off in full, but I can afford to pay you something each month so let’s make a deal”. If you are cash-flow insolvent and don’t have any assets you can sell or refinance and your creditors believe that is the best deal they can get, they are likely to accept a consumer proposal. They know you’re insolvent and, since they don’t want you to go bankrupt, they are usually willing to accept a reasonable proposal.
If you have a lot of debt, especially high-interest rate debt, talk to a licensed insolvency trustee to see if you are insolvent and what your options are. The sooner you talk with a trustee the more options you have. As I said, most people I talk to don’t need to file but the good news is there is no charge for an initial consultation and that is the first step to making a plan to deal with your debt.
Asset insolvency can be calculated by adding up the value of what you own and subtracting the total amount you owe all your creditors. Assets include the current value of your house less any expected selling costs, the black book value of items like your car, truck or boat and any cash-on-hand or investments. Subtract from this your mortgage, bank loans, credit card debts, personal loans and payday loans.
If you owe more than you own you are insolvent. This is because if you were to liquidate or sell everything you own, you could not generate enough money to pay back your debts. However for most people, this is not the common reason they are insolvent.
The majority of people we help are insolvent because their income is not sufficient to allow them to repay their debts.
Income insolvency is calculated by adding up all your after-tax income sources including employment income, support payments and any other earnings, then subtracting all your living expenses including housing costs, transportation, food, personal care, child care, tuition etc. If you don’t have enough income after supporting living costs to repay your debt then you are insolvent.
What if you are keeping up with your minimum payments? You may still be insolvent. Paying only the minimum does not get you out of debt. If all you are paying is the minimum payment on your credit card then you are basically paying only the interest and a very tiny part of the actual debt balance. That’s why, for example, if you owe $18,000 in credit card debt and your minimum payment is $540 a month, your statement says it will take you 298 months or 25 years to pay off your credit card balance!
So what’s the solution?
Do you need to file insolvency?
If you feel you can budget your way out of debt by improving your cash flow, use tools like our free budgeting template to help you create your own plan to pay down debt sooner.
Here are some common warning signs that you may need to consider bankruptcy:
- you rely on credit to pay for everyday living expenses
- you are paying off one credit card by drawing down on other debt
- you can only access very high cost debt like high-interest finance company loans and payday loans
- you are behind on payments or are barely keeping up with minimum payments
- you have maxed out your credit and cannot access any further loans from your bank or other reputable lender
If this sounds like you, and you are technically insolvent, there are two insolvency options to eliminate your debt, available through a licensed insolvency trustee:
If you are uncertain whether your debt problems are serious enough to consider a bankruptcy or proposal, contact us today for a free consultation. Four out of five people we help find they do not need to file insolvency. Our team of licensed insolvency trustees will help you explore all your options and point you in the right direction.