Taking on debt is often a means to survive financially. In my many years of helping people find debt relief, I know that most of my clients take on debt fully expecting to pay it back. So, what happens to cause someone to file bankruptcy? How can someone accumulate an average of $50,000 in credit card debt, payday loans, student loans, and tax debt which is the profile of the average person filing insolvency in Canada? And if you have more debts than you can repay and are considering bankruptcy, what does the bankruptcy process look like, and how does it help?
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Top causes of bankruptcy in Canada
Bankruptcy is a legal process where you surrender your assets and make monthly payments to a Licensed Insolvency Trustee, after which your debts are eliminated. A consumer proposal is a formal settlement arrangement to repay a portion of your debts.
If you cannot satisfy your financial obligations (pay your bills as they come due) and don’t have assets to sell that will cover the debt, you are in a state of insolvency. Being insolvent makes you eligible to file bankruptcy (or a consumer proposal) in Canada as long as you owe a minimum of $1,000.
Practically speaking, the average person who files insolvency in Canada owes around $50,000 in unsecured debts. They commonly owe between $20,000 and $30,000.
There are many reasons for bankruptcy in Canada, most of which you will notice are stressful life events that generally lie outside of an individual’s control.
1. Unexpected financial expense
Many people do not have the means to keep healthy savings for a car or housing repair or if a beloved pet requires an emergency vet visit. Easy payday loans or adding to credit card debt is often the short-term answer to these kinds of expenses. But, unfortunately, the borrower soon finds their monthly income can’t cover the monthly payments of these high-interest debt obligations.
2. Student loans
A common cause of insolvency among those aged 27 to 40 is student debt as the cost of tuition increases, and graduates find it hard to secure gainful employment in their field. To be eligible to have your student debt discharged in a bankruptcy or consumer proposal in Canada, you must have been out of school for seven years.
3. Family emergencies
Like the example of needing to take a beloved pet to the veterinarian’s office unexpectedly, other family obligations can contribute to money management problems. Taking care of aging parents or children with high needs may cause caregivers to extend their credit past the point of good financial health.
Often, well-meaning family members will co-sign loans or lend personal savings to help out someone they love. This type of financial support can over-extend their safety net and put them at financial risk themselves. Borrowing money for someone else can make you unable to make your monthly payments or deplete your bank accounts so that you are unable to cover your own extra expenses without using even more credit.
5. Job loss or income reduction
In most cases, if you are not working and have no income, there is no need to file bankruptcy. You are what we call ‘creditor proof,’ meaning you have no wages that can be garnished. However, job loss is still a cause of many people filing insolvency as they live on credit while off work. Upon returning to work, they now have more debt, may miss payments, and creditors start calling. Filing bankruptcy (or a consumer proposal) provides creditor protection to prevent your future wages from being garnisheed.
6. Living paycheque to paycheque
Most people who claim bankruptcy are employed. But, holding a job doesn’t mean that your income covers the cost of living expenses. Our average client’s household debt is 50% higher than that of the average household in Ontario. Much of this debt is accumulated by paying for living expenses like housing, food, and utilities because their income does not cover modest living costs. When you are living paycheque to paycheque, like the average person drowning in debt, you’re tempted to overextend your credit just to survive.
7. Rising cost of living
Inflation and rising interest rates decrease the amount of income available to stay on top of debt repayment. When essential goods cost more, more consumers turn to credit to make ends meet or reduce their debt payments to pay for the rising cost of living. Long-term inflation, combined with a decline in asset values – particularly home equity – due to higher interest rates, increase the level of consumer insolvencies. Inflation and higher rates drive someone who was previously able to keep up, to live paycheque to paycheque.
8. Illness or medical bills
When someone becomes ill or is recovering from an accident, they may have to take time off work. Sick leave, if you are eligible, still means a reduction in income. And part-time workers or those employed through commission-based work or freelance, are often not eligible for any sick pay to cover illness or medical bills. Many people turn to credit cards to pay for expenses and medical costs.
9. Separation or divorce
Nearly one in four people who declare bankruptcy have recently experienced a separation or divorce. When a couple dissolves, their financial situation drastically changes. Household expenses double, and the now separated couple are no longer sharing their income. As assets get divided, unexpected costs arise, such as furnishing a second home, purchasing another car, or remortgaging the family home. Additionally, where two incomes were paying back both partners’ debt, one spouse may assume responsibility for a higher share of debt repayment. Be aware, though; you are not legally responsible for your spouse’s debts, divorce agreement or not.
10. Spousal or child support
Providing spousal or child support on top of these new household expenses may add further stress to a divorced couple’s finances. Many parents and newly split couples find themselves extending their credit beyond any means of paying it back just to survive this major life change.
11. Tax debt
Insufficient withholding taxes due to a part-time job or RRSP withdrawal and not paying taxes on self-employment income as a form of cash flow are the two most common reasons people file insolvency due to tax debts. Due to the pandemic, we are also likely to see an increase in people filing insolvency for tax liabilities due to CERB and CRB payments they received that they have not yet paid taxes on.
A typical sequence of events that lead to insolvency
When I say that filing bankruptcy is not someone’s fault, the usual next question I receive is, ‘Well then, how does someone go bankrupt? How did they get in this situation in the first place?’
The path to bankruptcy is all too common. Unfortunately, our typical debtor (whom we call Joe Debtor) makes many of the same financial decisions along the way, and these decisions are not necessarily to their benefit.
The following provides an example of the downward spiral leading to personal bankruptcy. It is a composite of many of the stories I hear every week in our professional practice:
- Joe uses his credit card, takes on a car loan, or buys a house with what he thought was an affordable (or at least doable) mortgage. Just like any other Canadian borrower. At first, he keeps up with his payments. Then something happens – an extra expense, loss of income, divorce or another disruptive life event. Something that made it even harder to make ends meet.
- To get by, he uses up what little savings he has. Next, he sells things that he could easily turn into cash to pay his bills.
- He uses his credit cards as cash flow based on the assumption that things will get better if he could only make it through the next couple of months.
- Because he’s using his credit card but still making his minimum payments, he has good credit. This means he can easily qualify at this stage for $5,000, $10,000 or even $50,000 in new credit. Joe is sure things will improve, so he takes on even more debt.
- Things don’t improve, and so now he cashes out his RRSPs or sells any other assets he still has to raise more money to service his debt. If he’s able to do this, he has created a short-term solution with longer-term implications, not the least of which is that he will probably owe the Canada Revenue Agency additional taxes by converting his registered investments into cash.
- Next, he starts looking for loans or lines of credit to consolidate his debt. If he’s fortunate, he might still qualify for a loan at a major financial institution. Unfortunately, most of the banks and other major lenders will not extend Joe any additional credit by this point.
- Joe still feels he can borrow his way out of trouble, so he turns to the higher risk (and therefore higher interest) lenders. They are pleased to extend Joe a consolidating installment loan provided he will agree to 29% to 59% interest on the debt and perhaps pledge his car as security.
- Three or four months later, perhaps longer if Joe is good at juggling his payments, Joe comes to realize that he is in too deep and starts looking for other solutions. He calls our office, obviously distressed because he cannot handle his monthly payments.
What happens when you declare bankruptcy?
In Canada, bankruptcy is handled by a Licensed Insolvency Trustee (LIT). LITs are regulated by the federal government and trained in bankruptcy laws governing both personal bankruptcy and consumer proposals.
A Licensed Insolvency Trustee will first conduct a debt assessment and explain all available options for dealing with problem debt, including credit counselling, a debt consolidation loan, bankruptcy and a consumer proposal.
Then, if bankruptcy looks like the best solution, your trustee will prepare the required documentation to declare bankruptcy. Once these bankruptcy documents are signed, they are transmitted electronically to the Office of the Superintendent of Bankruptcy.
Once bankrupt, the debtor receives an automatic stay of proceedings. This bankruptcy protection prevents creditors from pursuing further actions to collect on debts included in the bankruptcy. While bankrupt, your duties involve making monthly payments and handing over any assets not exempt from seizure. Typical bankruptcy exemptions include a low-value vehicle, household furniture, personal belongs and RRSP savings. You are also required to attend two mandatory credit counselling sessions.
Bankruptcy lasts approximately nine months if this is your first bankruptcy and you have no surplus income. A bankrupt who earns above what is known as the surplus income limit will be bankrupt longer and will be required to make additional bankruptcy payments.
It is important to note that bankruptcy does not deal with secured creditors. While bankrupt you must maintain your mortgage and car loan payments if you elect to retain those assets.
Upon completion, if all goes as required, you will receive an absolute discharge and are then no longer obligated to pay back debts to unsecured creditors included in your bankruptcy. Each creditor in your bankruptcy will receive a dividend equivalent to their percentage share of any of the funds paid into your bankruptcy estate.
The fact that you filed bankruptcy will be noted on your credit report and remain for 6 to 7 years from the date of filing. During your credit counselling, your trustee will provide you information on how you can rebuild credit and improve your credit score post-bankruptcy.
Bankruptcy is a fresh start
Part of the narrative that many people tell themselves about their financial health is that they are fully responsible for their debt and any consequences that come from it. While it is important for everyone to manage their incoming and outgoing money, sometimes events happen in our lives that are completely out of our control. Bankruptcy can help correct the financial impact of those events. People of all ages, from someone in their 20s to seniors, take back control of their lives by getting help to declare bankruptcy.
Anyone struggling with debt with any of these symptoms and warning signs should reach out to a trusted and licensed insolvency trustee for advice.