If you’re facing a massive amount of debt, it’s easy to become overwhelmed. You may believe that you’ll never repay your creditors thanks to late fees and high interest rates.
No matter the reason you’re in debt—whether it’s due to job loss, reduced income, or the rising costs of raising a family—you can achieve financial freedom. If you need help to become debt free, in this guide to debt relief I’d like to help you understand how Canada’s debt relief programs work.
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What is debt relief?
Debt relief relies on the principle that if you are genuinely struggling with debt, creditors should not require you to repay more than you can afford or remain in debt for life. Debt relief allows you to negotiate with your creditors and settle your debt for less than you owe.
A debt relief company (in most cases, a Licensed Insolvency Trustee or LIT) works with your creditors to negotiate a debt settlement arrangement. You stop making payments to your creditors and make payments through the program. Upon completion, your debts are forgiven.
Pros and cons of debt relief
Debt relief is meant for those who have a large amount of debt that is not secured by property or other collateral. If you are struggling with your monthly debt payments or juggling one debt against another, debt relief may be a good way for you to reduce your debt.
To help you consider, here are the most common advantages and disadvantages of debt relief:
- Most of your debt is forgiven
- Interest is frozen
- Payments fit even the tightest budget
- You keep your assets
- You get out of debt without filing bankruptcy
- You will be debt free, usually in 3 to 5 years
- You get financial counselling to help you with the recovery process
- Debt relief will impact your credit score for a while, and you will need to take active steps to rebuild after the program is complete.
- Not all debt settlement programs are created equal. Depending on the program you enroll in, there may be additional fees especially if you work with a non-licensed debt consultant.
- Some of your creditors may not agree to negotiate, which can impact the outcome. There are programs which I’ll explain below that require all creditors to participate as long as the majority agree.
Debt relief vs debt consolidation
While debt relief is a way to settle your debt for less, debt consolidation is a way of taking the debts you owe and restructuring that debt to make your payments easier to manage financially.
With debt consolidation, you apply for a new loan and use the proceeds to pay off multiple small loans. Combining your loans into one bill is easier to manage and can help make debt repayment more affordable.
Debt consolidation loans come with lower interest rates, and you can spread your payments out over a more extended period.
With debt consolidation, you:
- Lower interest rates so you save money
- Get one, consolidated lower monthly payment
- Can get out of debt sooner
- May improve your credit score
Debt consolidation may work for you if you have debt stemming from multiple credit cards, but there are some downsides.
A debt consolidation loan doesn’t eliminate your debt; it just provides a better repayment option. Many people fail to factor in the risks of debt consolidation when considering taking on another loan.
You also need good enough credit to apply and be approved for a debt consolidation loan. Homeowners could use the equity in their homes to consolidate debts by refinancing or taking on a second mortgage. However, if you do not have any property to offer as security, an unsecured consolidation loan is out of reach for many.
And while debt consolidation may seem better for your credit than debt relief, it can hurt your credit just as badly if you take on more debt afterwards.
Will creditors forgive the debt?
Under certain conditions, most credit card companies and other creditors, even the Canada Revenue Agency, will entertain the idea of settling a debt for less than what is owed.
If a debt is very old, a creditor’s ability to sue is prohibited by limitation laws. If this is the only debt you have, you can likely negotiate a debt settlement in exchange for the debt collector’s full release directly.
If you have a lot of debt, creditors may settle if they think the alternative is for you to file for bankruptcy. In a bankruptcy, your debts are erased once you receive your bankruptcy discharge. If creditors believe they will receive less in bankruptcy than the debt settlement offer you propose, they will be inclined to take the deal.
How much are creditors willing to accept through a debt relief program?
As part of the debt relief process, you must submit a statement of your income and expenses along with a full list of any assets you own. This information helps a creditor review the reasonableness of your debt settlement proposal. They will consider how much they think you could afford versus how much they might receive if you filed bankruptcy. Creditors will expect to receive a little more than the bankruptcy option. They may also have set policies about the percentage of the debt they wish to recover. In most cases, an acceptable minimum settlement offer is around 30 cents on the dollar. If your income is higher or you have some valuable assets, you will need to offer more.
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Will creditors take legal action if I choose debt relief?
Your creditors’ rights to send your account to collection or sue during debt relief depends on the type of program you choose.
An informal debt settlement, without sanction by the court, does lead to the risk that your creditors may sue. If you stop making payments without some form of legislated protection, creditors will do what they need to enforce the collection of what you owe. This is one of the most significant risks in working with an unlicensed debt settlement company.
If you need creditor protection, you can file for debt relief through a consumer proposal. A proposal has the strength of the Bankruptcy & Insolvency Act behind it to provide a stay of proceeding to stop a lawsuit, wage garnishment and collection calls.
What kind of debts are suited to debt relief?
Debt relief programs are good for settling unsecured debt, such as:
- Personal loans
- Credit cards
- Lines of credit
- Collections and overdue bills
- Payday loans
- Tax debt
- Small business debts
If you need debt relief from student loans, income taxes, HST or payroll withholding taxes, then you will need to choose a debt relief program that can include those debts. In Canada, only a consumer proposal can deal with government debts. A consumer proposal, because it is a federally regulated debt settlement program, does have the ability to settle debt owed to the Canada Revenue Agency so is also a good option if you need tax debt relief.
One type of debt not suited to debt relief is secured debt. You cannot settle your mortgage, home equity line of credit or vehicle loan through a debt relief program. The good side of this is that if you file for debt relief, that means your mortgage lender or car loan provider cannot pull the loan. If you can continue to make your monthly payments, secured debts are not affected by a debt relief program.
How debt relief can affect your credit score
How you manage your debt, good or bad, will affect your credit report.
Using too much available credit will lower your credit score. If you continue to max out your credit cards and carry very high balances, your score will never improve. Credit utilization rates above 50% have a significant negative impact on your credit score, and credit specialists recommend utilization rates below 30% for the best scores. Most people considering debt relief, carry very high balances.
Another risk of a heavy debt load is missed payments. Missing payments is one of the worst things you can do for your credit score. Late payments remain on your report for seven years, so the longer you postpone dealing with your debt, the longer your score will stay low.
When considering debt relief, you want to weigh the benefits of settling your debt against the temporary hit to your credit by enrolling in a debt relief program.
A debt relief program will remain on your credit report for six years. That is true for both a debt management plan (credit counselling) or a consumer proposal.
If you’re suffocating under debt and having trouble making payments, you likely already have poor or bad credit. Sometimes the best action is to eliminate problem debt so you can build a whole new credit history.
If you determine that a debt relief program is right for you, you shouldn’t put it off. The sooner you settle your debts, the quicker your score will improve. Part of the debt relief process will involve giving you the information and tools you need to rebuild your credit. With a better score and an improved debt-to-income ratio, you’ll have greater access to better interest rates on new credit.
What are the different personal debt relief programs?
Your financial problems are unique to you, so it’s essential to find a debt relief program that best fits your needs.
When a non-profit credit counsellor summarizes your debts and prepares a repayment plan, this is called credit counselling. When working with a credit counsellor, they will develop a debt management plan (DMP), enabling you to repay your debt over time, usually five years.
Your credit counsellor takes your DMP to your creditors and presents it to them for approval. Individual creditors can opt-in or out of the program. If accepted, you’ll make one monthly payment to the counselling agency.
Credit counselling cannot settle debts for less than the full amount. However, your creditors will sometimes lower your interest rate, providing you with enough financial relief to pay off your debts.
When settling debt, you try to get creditors to agree to accept a lower portion of your debt.
You can try to negotiate a lump sum debt settlement on your own if you have the cash available. However, if you need a payment plan or your debts are large, it’s best to work with a Licensed Insolvency Trustee to file a consumer proposal.
Always know the credentials of the consultant you are working with. There are debt relief companies advertising consumer proposals, yet they are not licensed to provide that service. Before signing any contract or making any payments, ensure that you have met with a Licensed Insolvency Trustee for a full debt assessment.
The only government debt relief program in Canada is a consumer proposal. It is a formal, legally binding agreement that addresses all your unsecured debts.
A Licensed Insolvency Trustee facilitates the consumer proposal process, including helping you negotiate payment terms. You make a single monthly payment to your LIT, and then they pay each of your creditors. Upon completion, your debts go away.
Consumer proposals explained
Consumer proposals are the most popular debt relief option available to Canadians struggling with severe debt. The consumer proposal process is both safe and easy.
First, the Licensed Insolvency Trustee will help you prepare your offer then file your consumer proposal with the Office of the Superintendent of Bankruptcy (OSB).
Once filed, you stop making scheduled payments directly to your creditors. If your creditors are garnishing your wages for repayment, they must stop.
Then, the LIT will send the proposal to each of your creditors. The documents will include your settlement percentage, repayment plan and an overview of your financial situation and the causes of your financial difficulties.
Creditors have 45 days to respond by either accepting or rejecting the proposal. Their decision can be made before or at the meeting of creditors if one is scheduled.
Each creditor has votes equal to the total dollar value of the proven claims they submit to the trustee. If more than 50% of these votes accept the proposal, it is approved and binding on all unsecured creditors.
If your proposal is accepted, you will:
- be responsible for paying your agreed lump sum or periodic payments to the LIT
- retain your assets (contingent upon making payments to your secured creditors)
- attend two required financial counselling sessions
If your proposal is not accepted, you have the right to:
- make changes and resubmit it
- consider another debt relief option for solving your financial problems
- file for bankruptcy
Your debts will be regarded as forgiven if you meet the proposal conditions in full.
If you miss payments or your last payment is over three months past due, however, the proposal will be deemed annulled. At this time, unless an amendment to the proposal has been filed, your creditors can take legal action to collect the money you owe them. Only the court can order otherwise. Under certain conditions, the court can revive annulled consumer proposals.
For a successful consumer proposal, you want to work with a trustee experienced in negotiating a deal that works for both creditors and debtors. You want a deal your creditors will accept, but debt relief payments you can afford.
Getting relief through a licensed professional
It’s vital that you only go to an accredited professional for financial advice about dealing with your debt. If you’re not careful, you can end up paying exorbitant fees to a non-reputable company.
It is best to consult with a Licensed Insolvency Trustee to discuss your financial situation. Licensed Insolvency Trustees are federally regulated debt professionals. They provide advice and debt solution services to individuals and businesses with debt problems.
Why should you consider consulting with a Licensed Insolvency Trustee?
- An LIT will explain each debt relief option’s pros and cons and how they may help you overcome your money problems.
- The government only authorizes LITs to administer government-regulated insolvency proceedings (such as consumer proposals and bankruptcies) that allow you to dig out of debt.
- They will directly deal with creditors on your behalf once a proposal or bankruptcy is filed. They can also keep unsecured creditors from initiating or continuing any legal proceedings against you.
- If you decide to move forward with a consumer proposal, your LIT will work with you to develop a proposal to satisfy your creditors and one that fits your budget.
When you choose to work with an LIT, you know you’re getting advice from a qualified professional. Licensed Insolvency Trustees have demonstrated knowledge, experience, and skills to receive a license from the Office of the Superintendent of Bankruptcy (OSB).
Due to OSB oversight, LITs are subject to federal standards of practice, including a Code of Ethics for Trustees. If you’re unsatisfied with an LIT’s services or have a disagreement you cannot solve, you are free to file a complaint with the OSB.
The federal government also regulates the fees charged by LITs for consumer insolvencies. Trustees do not charge for the initial consultation, collection of information and preparation of the plan. Their fees are covered from the payments you make to your creditors and are payable only after the proposal is filed.
Gain your financial freedom
If you’ve been relying on your credit cards and other debt as a financial lifeline and it’s beginning to catch up with you, it’s time to look into unsecured debt relief options.
Hoyes Michalos & Associates is here to help you. We will explain all of the debt relief options available to you and find a solution you can afford.
Contact us today to schedule a completely free consultation with no obligations.