By the numbers: How to reduce your debt when you can’t repay
Canadians have debt — lots of it. But what can they do when the liabilities pile up to a point where it’s no longer possible to keep up with the payments?
The first thing to do if you’re in that pickle is to see if there’s a way to regain control of your finances while still making your creditors whole. This may involve consolidating your high-interest debts into a single loan with lower payments. Other options might be selling assets to repay at least some of what you owe or finding ways to boost your income, like getting a second job or renting out the basement.
“There’s a whole bunch of things that are least invasive,” said Laurie Campbell, CEO of non-profit credit counselling agency Credit Canada Debt Solutions.
“If you can pay the debts yourself over a period of, say, 24 months or less, dealing with it yourself is often the best option,” said Douglas Hoyes, a licensed insolvency trustee (LIT) and co-founder of Ontario-based Hoyes, Michalos & Associates.
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Still, that’s not always the case. And if you can’t dig yourself out of the hole on your own, you have three main options: a debt management plan; a consumer proposal; or filing for bankruptcy.
A debt management plan (DMP) is an informal process in which a credit counselling agency asks your creditors to voluntarily agree to consolidate your debts into one more affordable payment. Credit counsellors can usually reduce or eliminate the interest on your debt, but you’ll still have to repay 100 per cent of the principal.
Your monthly payments through a DMP may include a monthly administrative fee. Non-profit credit counsellors usually have self-imposed caps on these costs and will charge you based on your ability to repay. Sometimes they’ll even waive the fee entirely.
These agencies also receive a donation from some creditors based on the size of your debt repayments. As donations, the payments are, of course, voluntary. Only some creditors donate, but this money is an important source of funding for the non-profits.
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A consumer proposal (CP), as the name says, is about making a proposal to your creditors. Generally, in a CP, the debtor offers to pay back less than the principal owed. If the creditors agree to the proposal in a majority vote, it becomes legally binding for all of them. A CP can only be administered by an LIT, who will put together the proposal taking into consideration your income, assets and some of your expenses.
Your creditors will get only a portion of what you pay back, with the rest going to fees that are set by law. There’s a fixed cost of about $1,800 that mostly goes to the LIT. In addition, the LIT receives 20 per cent of the funds available for distribution. Because the fees are federally regulated, every LIT in the country will charge you the same way.
A bankruptcy is also a legally binding process. You generally don’t get to keep your assets in a bankruptcy proceeding, but there are some important exceptions. For example, depending on what province you live in, you may be able to keep some of the equity in your home, your car, the savings in your Registered Retirement Savings Plan (RRSP), or work-related tools. In addition, you may be able to buy back the assets in a bankruptcy, without the trustee liquidating them, according to Greg Best, a licensed insolvency trustee at B.C.-based Smythe Insolvency.
The fees involved in a bankruptcy can vary significantly based on factors such as your income and assets. However, the minimum cost of a first-time bankruptcy is $1,800, payable over the term of the proceeding, according to MNP, one of Canada’s largest insolvency firms.
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Where the money goes
Confused about how the different options actually work? Here are a couple of examples.
Debt management plan: $10,000 in debt
Let’s say you owe $10,000 in credit card debt. The interest rate on your debt is a typical 19.99 per cent and the interest charges are piling on fast. You can’t keep up and decide to file a DMP with a non-profit credit counsellor.
You’ll still have to pay back the full $10,000 but will probably avoid paying any interest on that debt. Both Credit Canada and the Credit Counselling Society (CCS), two of Canada’s best-known non-profit credit counsellors, said they can typically get creditors to waive off all interest charges.
In addition to repaying your creditors, at Credit Canada and the CCS you’d have to pay a fee of up to 10 per cent of your $10,000 principal. Once your credit counsellor has set your fee, how much a DMP will cost you depends on how long it will take you to extinguish your debt.
For example, the CCS said most of the debtors it helps take 3.5 years to complete a DMP. Over that time horizon, a debtor would save nearly $6,500 in interest charges and typically pay just under $510 in fees, according to numbers the organization shared with Global News.
If the debtor took you five years to repay your $10,000 debt, she or he would be spared more than $9,000 in interest but would have to pay just over $700 in fees on average.
Still, CCS president Scott Hannah said his non-profit foregoes that fee entirely in about five per cent of cases, mostly for people with small amounts of debt.
In addition to your fees, non-profit credit counsellors receive a donation from some creditors that’s typically equal to a percentage of the funds repaid. At the CCS, the average aggregate rate is 18 per cent, Hannah said. Credit Canada’s Campbell put that figure at 16-17 per cent. In our $10,000 DMP example, that would work out to between $1,600 and $1,800 in donations. The money goes to fund the agencies’ free debt counselling and financial literacy services.
Both the CCS and Credit Canada said just 20 per cent of their clients establish a DMP.
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Debt management plan: $50,000 in debt
Now let’s say you have $50,000 in credit card debt.
According to the numbers shared by CCS, with a 3.5-year DMP, you’d pay just under $2,350 in out-of-pocket costs on average, on top of having to repay the full $50,000. On the other hand, you’d save nearly $32,500 in interest.
Stretch the repayment plan to five years, and you’re typically looking at $3,325 in fees but more than $45,000 saved in interest.
In addition, credit counsellors might receive between $8,000 and $9,000 in creditor donations.
Consumer proposal: $10,000 in debt
Now let’s see what might happen to your $10,000 in unsecured debt if you filed a consumer proposal.
The actual amount you’d have to repay would depend on a number of factors, including your income and assets. All this affects what your creditors would receive in bankruptcy and what creditors would be willing to accept in a consumer proposal, which must be a more attractive deal, both Hoyes and Best said.
In this example, we’re assuming you have a gross income of $34,000 a year and bring home $2,350 after tax every month. You have no assets that would be exempted in a bankruptcy.
According to numbers shared by Best, the B.C.-based LIT, in a consumer proposal, you may be able to repay just $6,000. That would work out to $100 in monthly payments over a five-year period.
Of the $6,000, around $3,200 would go to your creditors, $2,500 to the trustee, with the rest spent in other fees and taxes.
In general, in a consumer proposal for $10,000, an LIT might be able to slash the total cost to the debtor to as low as $3,000, although creditors may not accept the proposal because of the small amounts of money involved, Hoyes said.
On the other hand, sometimes debtors repay 100 per cent of the principal in a consumer proposal, Best said.
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Consumer proposal: $50,000 in debt
If there was a $50,000 debt noose hanging around your neck, here’s how a consumer proposal might play out.
Best supplied two examples, each based on real-life cases. In the first, the debtor makes $56,500 a year before tax and pays $650 a month in childcare costs. Her assets include $20,000 in a Registered Retirement Education Savings Plan (RESP), which would not be exempted in a bankruptcy.
Best also gave a second example of a debtor making $48,000 a year with no assets that would be exempted in a bankruptcy. Notably, $20,000 of $50,000 she owes is tax debt, which can only be discharged in a consumer proposal or bankruptcy.
In both cases, Best said debtors might be able to repay just $18,000 through a consumer proposal. That would work out to a $300 monthly payment over five years.
Of the $18,000, $4,915 would go to the trustee, and $12,815 to creditors.
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Factors to consider
Whether you should go for a DMP, CP or bankruptcy depends on many things and is a decision to be taken with professional help. Credit counsellors may tell you that your best option is a proposal or bankruptcy and refer you to a LIT. Vice versa, trustees may also refer you to a credit counsellor.
The list of factors to consider is long, but here are some of the main ones:
How much you owe: Consumer proposals come with fixed costs, which means that, for smaller debts, a DMP may make more sense, Hoyes said. The typical borrower he sees, he added, has $40,000 to $50,000 in unsecured debt.
By contrast, Hannah said the average amount for DMPs at the CCS is around $25,000.
Type of debt: What you owe also matters. A DMP, for example, cannot reduce the interest you owe on tax debt. That said, even a bankruptcy won’t get rid of your government student loans unless you’ve been out of school for seven years or more.
Your income, budget and cash flow: The obvious point here is that if you can’t afford to repay the 100 per cent of the principal, a DMP is not an option.
However, there are many more things to think about.
For example, your after-tax income affects how much you’d have to pay back in a bankruptcy. In general, if your household income exceeds a low threshold set by the federal government, you may have to hand over half of the surplus to the LIT for distribution to the creditors, something known as “surplus income” payments.
“As silly as it may sound, some people can’t afford to go bankrupt because they can’t afford the surplus income payment. So we structure a consumer proposal around that,” Best said.
The presence of surplus income will also lengthen the term of a first-time bankruptcy to 21 months, instead of the nine months it takes for a so-called automatic discharge.
Assets: Your home, car, the cottage … what you own in assets also matters.
For one, if you choose a consumer proposal or bankruptcy, the government is going to want to make sure you really can’t afford to pay back what you owe. And having debts that exceed the value of your assets is one key definition of insolvency, Hoyes said.
What kind of assets you own can also make a difference, Best said. The presence of assets that would not be exempted in a bankruptcy — such as savings in a RESP — may tilt the balance in favour of a consumer proposal, he said.
Other circumstances: If anyone is garnishing your wages or if creditors have filed lawsuits against you, only a consumer proposal or bankruptcy can put a stop to that.
Credit counselling: Help with budgeting, tackling debt, financial goal setting and other money-related challenges is a big part of what non-profit credit counsellors do. They may also help you rebuild your credit history once you’re done with a DMP.
Non-profit counsellors can usually refer clients to a vast network of contacts who can help with a variety of issues, such as addiction, mental health, legal services, housing support and tax filing services.
LITs also provides some guidance. By law, they must hold two counselling sessions for anyone who opts for bankruptcy or a proposal.
Impact on your credit score: A DMP will stay on your credit record for two years after completion of the program. With a proposal, the period is three years. A first-time bankruptcy, by contrast, will show on your credit history for six or seven years.
When thinking about how long you’ll have to wait to have your credit record wiped clean, it’s important to consider how long it will take you to repay your reduced debt load. Completing a consumer proposal may take you less time than opting for a DMP, if the amount you have to repay is significantly lower, according to Hoyes.
In a consumer proposal the amount of the monthly payments is usually calculated based on a maximum term of five-years, Best said. However, debtors can repay a proposal in a shorter period of time, he added.
Sometimes, there is no option
Sometimes, even bankruptcy is unaffordable. If you have very little income and few or no assets, you may not be able to cover the fees.
Researchers estimate there may be between 11,000 and 15,000 Canadians who may find themselves in such a predicament every year.
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