Consumer Proposals and Bankruptcies
I read some pretty poor advice this week on a facebook group I am in and it got me thinking about all the conversations I have had this year regarding the topic of consumer proposals and bankruptcies. Roughly guessing, I would say I spoke to around 30 potential clients this year that were in an active Consumer Proposal or Bankruptcy and roughly half of those people had no idea what that meant to their credit score and mortgage qualifying ability. In light of the financial situation that many Canadians are facing right now after a tumultuous year of job loss, quarantine, mortgage deferrals and unexpected expenses I thought I would tackle this tricky topic here to shed some light on an otherwise confusing situation.
Consumer Proposal In a 'CP' you would visit an insolvency trustee to arrange for a debt repayment plan. The insolvency trustee negotiates a portion of your debts to be paid off with each of your creditors and lumps them into one consolidated loan payment. At this point, your creditors are paid a settlement, no further interest is accumulated on the debt and creditors will stop calling you. The Insolvency trustee includes their initial fees in your new loan amount and takes a percentage of your loan payment for their services. The Credit Counselling Society website notes a $1500 set up fee plus 20% of your monthly loan payment as their income from the process. You then work out a monthly re-payment amount which you will pay back over a period of time up to a maximum of 5 years.
In a CP you do not give up any assets like vehicles or your home but you do need to show that you are unable to make debt payments. You cannot include a mortgage in a CP.
One item that is largely overlooked by insolvency trustees when explaining a CP to a potential client is the credit score impacts this will have and the ability to qualify for new loans or mortgages. A CP is registered on your credit bureau almost exactly the same way as a Bankruptcy. From most lenders perspectives, they are one and the same. Your credit score will take a substantial pummeling from this as well as the history of the CP staying on your credit bureau for 3 years after your final payment is made meaning it will have adverse effects to your credit report for up to 8 years. It should also be noted that even with the past history falling off the current bureau, it is always possible for a lender to see that you have had a past CP registered. You will not qualify for a new mortgage with a traditional lender until 1-2 years after the final payment has been made on the proposal and you will need to have rebuilt your credit score with 2 years history of 2 trade lines reporting positive and responsible credit use with no late payments etc. This means, even if you have a current mortgage which is paid on time and is in good standing, you will not qualify to refinance or transfer your mortgage for lower interest rates - or sell your home and port the mortgage - or obtain a new mortgage - for any reason for up to 7 years with a traditional lender. You may qualify with an alternative or private lender, however, you will need to have a much more substantial equity stake or down payment (more than 20%) and the interest rates you will be offered will be higher to compensate for the higher risk to the loan.
In a bankruptcy your debts and assets are weighed out and some of your assets may be used to repay debts before wiping out the remainder of the debts for a 'fresh start'. This process won't always include losing your home (as they only consider the equity stake you may have in the home) but it could. Each province has different criteria for what assets you can keep in a bankruptcy. All other assets are assigned to the trustee to be sold and money from the sales is used to settle debts with your creditors. There are plenty of factors that are taken into consideration with a bankruptcy like income surplus which could mean you are ordered to pay a portion of the income surplus back to the trustee for a certain period of time to help settle accounts. Insolvency Trustees charge a fee for their time and the paperwork required to file a bankruptcy and is dependent on your personal factors. Not all debts can be included in a bankruptcy. Student loans that are under 7 years old, child support, alimony, government debts and fines among other items are excluded from the bankruptcy and will still be due. The bankruptcy process takes a minimum of 9 months with numerous criteria you need to meet in order to receive a discharge from the bankruptcy. Mortgage qualifying rules are the same for a bankruptcy as the CP - you will need to be 1-2 years past the discharge of the bankruptcy with rebuilt credit for traditional lenders. Again, private or alternative lenders may be available sooner, however, you will require much more down payment/ equity and you will pay higher interest rates to account for the risk. Your credit score will take a more dramatic pummeling from a bankruptcy and the history will remain on your credit bureau for 6-7 years depending on the province with the registration being available to lenders to see for the rest of your life. If your bankruptcy included a mortgage, or a balance due from one of the 3 mortgage insurers due to a shortfall on the sale of the home in a foreclosure for example, you will have an even tougher time qualifying for a new mortgage again in the future. In this instance you will likely need to have more down payment and perhaps longer than the 1-2 year wait period depending on the parameters around your bankruptcy. There is no hard line answer on this as it will be evaluated on a case by case basis by the lenders and insurers with all future financing applications.
The Bottom Line
If you are in a position that debt is suffocating you or causing hardship to your life, a CP or bankruptcy may in fact be the best path to take, however, it is important to plan ahead and know what that will look like for the next 2-7 years of your life. If the debt is not suffocating quite yet and you think that you can manage it, there are a few options that can be explored before committing to one of these scenarios. Debt consolidation loans - if you have high interest incurring debts and you are making the payments but not really getting ahead, you may consider obtaining a consolidation loan from a bank which will have a much lower interest payment and a set monthly payment which will help to pay down the debt, not just service the interest charges. You may also consider a personal line of credit which would come with a lower interest rate than a credit card for example if credit card debt is what you are having trouble with. Balance transfer credit cards can also be a useful stopgap to transfer your debts from a higher interest rate to a 0% or very low interest rate card for a 6 month or more period of time which would give you time to pay down the debt without incurring more high interest charges. Refinancing your mortgage may be a possibility if you have a sufficient equity stake in the property. You can borrow back up to 80% of the appraisal value of your home in a refinance to take cash out to pay off debts and push out the amortization to get the payments down essentially consolidating your debts into your mortgage and having one payment at a much lower interest rate than any other loan. Even in scenarios where you don't have the equity to take out cash, you might be able to push the amortization back out to get the payment amount down low enough to free up monthly cash.
Refinancing vehicle loans is possible as well, you typically cannot borrow back against the vehicle - but you can push the current debt out over a longer period of time to get the monthly payments down.
Downsizing your life may not sound appealing, but it may be worth considering how much you are paying on rent, mortgage or even your vehicle loans and if you truly need to be driving something that pricey or living in a property at the price point you are. A few years of a downsized cost of living could help you dramatically to pay down debts and get your feet back under you. Set a budget and put away the credit card. One item that not many people realize is that once you let a balance carry over from one month to the next on your credit card, all new charges from that point on are charged interest from the day they are added to the card. Many people assume that interest only begins accumulating on those new charges after a month is passed but that is not the case. Any card with a carried over, unpaid balance, will begin accumulating interest on any new charges from the first day they are charged. It is good practice to pay your card off in full every month. If you can't pay it in full - stop using it until you have the card paid off fully. I know this is easier said than done, but the more you can avoid paying interest on groceries and gas the more you will have to pay your debts with. Don't ignore your debt, the longer it sits the more debt there will be. Regardless of which path you choose one thing stays the same - you will eventually need to choose and the longer you wait, the more it will cost in both time and money. As always, if you have any questions feel to reach out to me anytime at 780-720-4034