If you have too much debt, there are five options for eliminating debt. If none of these bankruptcy alternatives will work for you, the sixth option is to consider filing for bankruptcy; however, bankruptcy should always be your last resort.
- Personal budgeting. Make a budget and pay off debts on your own.
- Debt consolidation loan. Apply for a new loan to pay off multiple smaller debts.
- Credit counselling. Work with a credit counsellor to arrange a repayment plan.
- Debt settlement. Talk with your creditors to reduce interest or make a payment offer.
- Consumer proposal. Make a legally binding debt settlement with your creditors to pay back less than you owe.
In this post, I’m going to review these different approaches to debt reduction.
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DIY debt solutions
It’s possible to reduce your debt on your own if you are not already living paycheque to paycheque, and you can find ways to reduce your expenses drastically enough to funnel additional money towards debt repayment. The best place to start is with a list of your debts. You can use our free excel debt repayment worksheet as a start.
Next, you need to decide which debts to pay off first. There are two popular debt repayment methods to consider.
With the avalanche method of debt repayment, you pay off your debts from the highest to the lowest interest rate. This is my preferred method of paying down debt. Paying off high-rate credit cards and payday loans first reduces the amount of money you are wasting on interest faster, allowing you to get out of debt soon.
The snowball method involves paying off debts from the smallest amount owing to the largest balance owing. The motivation of paying off some debts can help keep you on track with your goal to become debt free. If you have a series of very small debts, the snowball method can also help you get these payments out of the way, making managing your bills a little easier in future months.
The key to budgeting your way out of debt is to stop using your credit cards and lines of credit to pay for things. You want your balances to go down, which means you must stop putting new charges on these accounts. Use cash to pay for expenses while you pay off your credit cards.
Negotiating with your creditors
I generally advise against using a for-profit debt settlement company. These agencies do not have a good success rate and can do more harm to your credit than good.
However, there is nothing harmful in picking up the phone and negotiating with your creditors on your own. You can ask for more time to pay your debt, an interest rate reduction or even ask if they will accept less than the full amount due in exchange for erasing the rest of what you owe.
Here are some quick tips if you are going to negotiate with creditors on your own:
- Write down what you want to offer upfront
- Make sure you can afford what you offer
- Getting any deal in writing before you make a payment
Debt consolidation loan
A debt consolidation loan is a loan used to pay off multiple smaller debts. It allows you to combine multiple payments into one smaller monthly payment, generally at a lower interest rate and spread over a longer period of time. Of course, debt consolidation doesn’t reduce your debt unless you can pay more towards the principal each month.
To qualify for a debt consolidation loan, you will need to have a reasonable credit rating, sufficient income to support the monthly payments, and possibly some assets to pledge as collateral in case you default on the payments.
And that is the big risk with a debt consolidation loan. If you default on a secured debt consolidation loan, you may lose your car, house or other assets.
A credit counsellor can negotiate a repayment plan where you pay your debts in full but at a reduced interest rate. This is called a “Debt Management Plan” and works well if you can repay your debts in full.
A credit counselling program will cost an additional 10% of what you owe. So if you repay $12,000 in debts through a debt management program, your total cost will be $13,200.
The advantage of working with a credit counsellor is that they can set you up on a monthly payment program and help keep you on track with your payments. They cannot, however, negotiate a deal to pay back less than you owe.
A debt management plan will affect your credit rating, as any debts included in the program will be marked as included in a repayment program (R7).
A consumer proposal is a legally binding settlement between a debtor and a creditor. It typically involves the debtor making one monthly payment, on an agreed-upon settlement amount, over a period of no more than five years. At the end of the proposal period, the debtor is then released of any remaining balances, which may be left from their original amount of debt.
A consumer proposal is an option if you can’t pay your bills anymore. In other words, if you cannot pay back your debts in full, on your own or with the help of a credit counsellor, then a consumer proposal can provide needed debt relief.
A consumer proposal is a bankruptcy alternative that can eliminate more than credit card debt. As a government debt relief program, a consumer proposal can deal with tax debts, student loans, payday loans, and other unsecured debt.
As with a debt management plan, a consumer proposal is a repayment plan that will appear on your credit report as an R7.
If you are struggling with debt, talk with a Licensed Insolvency Trustee early about your financial situation. Trustees are trained and licensed to discuss all ways out of debt, not just a consumer proposal or bankruptcy.
What you do not want to do is sell off assets, liquidate your RRSP or jeopardize other assets with a new loan. Discussing options like a consumer proposal with a Licensed Insolvency Trustee can ensure you preserve these assets while you eliminate your debt.