Hoyes, Michalos & Associates Inc. is not a bankruptcy firm – we are a “fresh start” organization. We know that bankruptcy is not your only option. When you call us for help with overwhelming debt, we explain all the alternatives to bankruptcy in Canada. You might be surprised to know that less than 10% of the people who contact us for help actually file bankruptcy. We help them avoid bankruptcy by looking at other options. In this post we will look at the top 5 bankruptcy alternatives.
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Bankruptcy Alternatives in Canada
If you have more debt than you can handle, there are solutions that you can explore. We’ll explain these in more detail below, but generally the top 5 alternatives to bankruptcy in Canada are:
- Repayment of debt through personal budgeting,
- Refinancing debt with a debt consolation loan,
- Repayment under a debt management plan through a credit counselling agency,
- Informal debt settlement through direct negotiation with your creditor,
- Avoid bankruptcy and eliminate debt with a consumer proposal.
No one solution fits everyone. There are pros and cons for each option, which we detail below. Our professionals are happy to talk to you, either over the phone or at a free 30-minute consultation about your financial situation and which option makes most sense for you.
How to Avoid Bankruptcy
Many of us struggle financially at some point in our lives and may even consider filing for bankruptcy as a way to manage our debt. Most of the time, this extreme decision can be avoided in favour of an alternative that allows you to take charge of your debts without the drastic step of declaring bankruptcy.
Repaying debt isn’t easy, and the first question should be “Can you afford to repay your debts on your own?” To answer this question, you need to create a personal budget to see how much money you have available each month to pay down your debts. Then, make a list of all of your debts and monthly payments and see how long it will take to pay them off.
To help you do this we have created a free and easy to use excel Debt Repayment Worksheet. This spreadsheet will show you how much you need to pay each month to pay off your debt in 1 year, 2 years, 3 years and up to 5 years.
If, through this analysis you cannot repay debts like credit card debt in a reasonable period, say 5 years, move on to the next option.
Debt Consolidation Loan
A debt consolidation loan allows you to combine several outstanding credit cards and bank loans into one single loan. If you qualify for a debt consolidation loan, you use this money to repay your other debts. You will now repay one consolidation loan, which typically has a lower interest rate than your other debts. This doesn’t solve the entire problem – you still have debt. However, it does make the payment much more manageable since you would only be making one payment versus several different payments.
You have two opportunities to consider when consolidating debt through a new debt consolidation loan:
- You can lower your interest rate, thereby reducing your monthly interest costs, and
- You can lengthen the term of the loan, lowering your monthly payment but potentially increasing the total interest you will pay.
Example of the benefit of a lower interest rate: If you have $20,000 in credit card debt and make payments at a rate of $500 a month at 29% interest it will take you 5 years and 4 months to pay off your credit card debts. If you can only afford $400 a month, that same credit card debt will take 8 years and 4 months to repay. However, if you can get a debt consolidation loan at 8%, paying $400 a month will eliminate your debt in 5 years and 2 months. In effect, getting a lower interest rate saved you 3 years in debt payments and more than $15,000 in interest.
Example of the cost of a longer term: Let’s assume you have $25,000 on a bank loan with a 5-year repayment term at 6%. Your monthly payments are roughly $480 a month. If you refinance this loan with a second mortgage (and for ease of comparison we will assume the same 6% interest rate) but extend the term to 15 years, your monthly payment drops to $210 a month. However, by extending the term you will pay almost $9,000 extra in interest over the length of the new loan.
Clearly these are extreme examples, however when considering a debt consolidation as an alternative to bankruptcy, these are the costs and benefits you need to consider.
You can consolidate debt through an unsecured debt consolidation loan or a secured consolidation loan like a second mortgage. The first option generally comes with a higher interest rate. The second option requires that you have sufficient equity in your home to put up as collateral to qualify for refinancing.
Debt Management Plan
A debt management plan, filed through a reputable, non-profit credit counselling agency, allows you to consolidate your monthly debt payments without having to qualify for a new loan. This type of debt repayment plan is a good option if:
- You only want to consolidate a few, small debts;
- You have bad credit and so would not qualify for a low-interest consolidation loan through a traditional lender.
Under a debt management plan, you must repay your debts in full. You may be eligible for interest relief, however there is no debt relief with an alternative like a debt management plan.
Example of payments under a debt management plan option: If you have $20,000 in credit card debt and choose a debt management plan over 5 years, your payments would be $333 a month. This is less than the pay it yourself alternative of $500.
Credit counselling can help you if you have a consistent income stream but are struggling to keep up with both interest and principal payments on your debts. A debt management plan, through a credit counsellor will allow you to repay your debts with a low interest rate and sometimes even with no interest.
For this alternative to be a good option it should:
- Deal with most of your unsecured debts
- Be affordable and sustainable.
The problem is however, that these types of repayment plans aren’t helpful if you are repaying income tax debts or any other type of government debt. In addition, you will still be required to repay your debts in full. While interest might stop, you cannot settle your debts for less than 100% of the outstanding balance you owe now.
We have met with many people who have not been able to keep up with the higher payments in a debt management plan and who eventually chose to file a consumer proposal instead.
Informal Debt Settlement
If you’ve been struggling with your debt for quite some time and your debts are small and fairly old, you may be able to settle your debt on your own with your creditor for a lower amount than the one you’re currently contracted to repay. You can sometimes repay around 50% of your overall debt and in some cases some companies will accept even less.
A word of caution: There are many debt consultant and ‘credit counselling agencies’ who offer to help you settle your debts for pennies on the dollar. In general, these debt settlement companies are not cost-effective. They often charge an ongoing fee during which time they are either not in contact with, or cannot get agreement from, all your creditors. In the end, they often refer you to a Licensed Insolvency Trustee to file a consumer proposal, but only after you have made large, unnecessary monthly payments, often under some form of written contract.
Avoid Bankruptcy With a Consumer Proposal
Another option that is becoming more common is a consumer proposal. A licensed insolvency trustee, acting as an administrator, will negotiate on your behalf with creditors to come to an agreement and settle your debts. The great thing about consumer proposals is that they can help you to negotiate an extremely low settlement.
For example: If you owe $40,000 to different creditors, they may be willing to negotiate for as little as 30% of the amount you owe. In our $20,000 example, your monthly payment could be as low as $100. This can help tremendously, because your debt will be paid off faster. You will typically make one monthly payment over a period of up to 5 years and you can pay it off earlier if your financial situation improves.
Creditors will accept a deal offered through a consumer proposal administrator because they would rather receive some amount of money from you as opposed to less in a bankruptcy. Often, when someone uses the services of a consumer proposal company, they are not too far away from having to declaring bankruptcy. Their creditors are looking for the best recovery for themselves and sometimes a that is a consumer proposal. As a result, a proposal is a win-win for both the debtor and their creditors.
Advantages and Disadvantages of Avoiding Bankruptcy
If you are considering filing for bankruptcy, talk to a debt expert first. In some situations, a bankruptcy turns out to be the best option. The key is to talk with a licensed professional about the advantages and disadvantage of avoiding bankruptcy, so you can make an informed decision.
There are other options available to you. To help you choose which option is best for your personal situation, contact Hoyes Michalos to book a free consultation with a Licensed Insolvency Trustee today. We’ll help you find relief from your debts.