We receive a lot of comments on our Facebook page from individuals struggling with debt who are afraid to consider something like a bankruptcy or consumer proposal because it will have a negative effect on their credit. Yes, filing bankruptcy or a consumer proposal will appear on your credit report. But so will many other bad credit activities which may be harming your credit score already including:
- Maintaining high credit card balances relative to your limit;
- Regularly exceeding or maxing out your credit limit;
- Applying for multiple credit cards and loans; and
- Having mostly credit card debt.
The truth is if you have too much debt, you probably already have poor or bad credit and it’s getting worse every day that you continue to struggle.
When you have a low credit score, your credit options are limited and those options that you do have are very costly. Even if you have a clean credit report, you may not have enough capacity to get more credit.
Having to rely on loans that carry very high interest rates means that you end up using a larger portion of your income to maintain your debt payments. The result is a cash flow shortage, forcing you to turn to more credit to make ends meet. This kind of bad debt cycle is exactly the type of situation every person we talk to faces each and every day. It usually breaks when they find out they have no more debt options left.
While it may sound good to read a list about how to rebuild your credit, the steps are meaningless if you are caught in a quagmire of debt. Deal with the debt first, then begin the credit repair process.
Still not sure you believe me? OK, let’s run through a case study. Taylor was a 40 year old, single, graphic designer. Work in her field was fun and challenging, but not necessarily steady. A few layoff periods caused her to rely on credit cards to get by and her debt ballooned. After returning to work, she faced almost $33,000 in unsecured debts and a car loan.
- Credit card A: $8,500 on $10,000 limit
- Credit card B: $2,000 on $2,500 limit
- Credit card C: $2,500 on $2,500 limit
- Store card (furniture financing): $10,000 on $10,000 limit
- Car loan: $23,000 (original $27,000 – 6 year term, 58 payments remaining)
Looking at Taylor’s situation, her credit utilization rate was 88% – way above the recommended 30%. In addition, credit card and high debt financing totaled half of all of her debt. Her credit capacity for new credit was almost nil, unless she wanted to start considering expensive alternatives like payday loans. What’s worse is that her monthly debt payments were $1,190 a month using up 48% of her take home pay. It would be difficult for Taylor to lower her credit utilization rate and build a better credit profile while paying down this existing debt. No way would she be able to apply for better credit. Taylor chose to file a consumer proposal and clear up her debts.
Taylor’s Credit Rebuilding Process
- File a consumer proposal for $10,500 based on her income to eliminate her $33,000 in debt. That was a savings of $22,500.
- Make here monthly payments of $175 a month for 60 months towards the proposal. Her new payments were now only 7% of her monthly income, a big drop from 48%.
- The elimination of her high debt payments increased Taylor’s cash flow sufficiently so that she no longer needed credit to balance her budget.
- Set aside $100 a month of the amount she was saving in a TFSA for an emergency fund in the event of another temporary period of unemployment and for future savings.
- By the time her proposal was complete Tailor had a TFSA balance of $6,000.
- Using a portion of the money she saved during proposal, Taylor applied for a $1,000 secured credit card for personal convenience and to begin the process of rebuilding her credit. She consistently paid off the full credit card balance each month, which provided future lenders a history of consistent debt payments and a low utilization rate on her new credit card.
- Three years after signing up for her proposal, Taylor also paid off her car loan. Her consistent loan payments during her proposal also helped to rebuild her credit. And with her savings she was a long way towards having a good down payment when she would need to replace her car.
- Two years after her proposal was completed, Taylor was able to apply for a small RRSP loan, a further step in showing her ability to manage credit wisely.
- Three years after her proposal was completed, the notice of her bankruptcy was removed from her credit report.
So yes, a proposal did appear on her credit report however Tailor learned to live without credit during her proposal (largely because she no longer needed credit to pay for living expenses) and was able to start rebuilding her credit while in the proposal.
This same process works whether you file a bankruptcy or proposal. By the end of your proceeding, you can have savings in your bank account and successfully restore your finances and credit in the event you want to qualify for another car loan or a mortgage in the future. If you have significant debts on your credit report today, it is unlikely you will achieve those objectives any sooner while trying to eliminate high cost credit card debt on your own.
If you’d like to ask more about how a proposal or bankruptcy can eliminate your debt, and what the steps are to rebuild your credit, contact one of our Licensed Insolvency Trustees for a free consultation.