Debt management programs vs. Bankruptcy: Which one’s right for you?

COVID-19 has amplified financial uncertainty for millions of Canadians. Households have faced loss of income through several rounds of lockdowns and a topsy turvy economy, and some have experienced rising debt loads as a result. 

For those who can no longer make ends meet, it’s important to understand there are options available to eliminate debt and achieve a financial fresh start. Three such options include Bankruptcies, Consumer Proposals and debt management plans. These may all offer much needed relief and a path to debt freedom, but each gets to that destination in a different way.

Let’s take a closer look at each proceeding to understand how they work, the benefits and drawbacks of each, and situations when they may be applicable and advantageous for you.

Debt management plan

A debt management plan (DMP) is an informal settlement with your creditors which is typically administered by a credit counselor. The process requires you to pay the full outstanding value of your debts. However, a DMP may significantly reduce your interest costs or eliminate interest costs altogether. Rather than paying each of your creditors individually, you would make a single monthly payment to the credit counselor, which they would then distribute to your creditors. 

DMPs are completely voluntary for both you and your creditors, meaning you (or your creditors) may withdraw from the agreement at any time without penalty. A DMP is still possible if only some of your creditors choose to participate in the settlement.

Pros

• Simplifies budgeting and consolidates several debts into a single manageable monthly payment
• Credit counselor will negotiate with creditors on your behalf
• Potential reduction or elimination of interest

Cons

• Cannot include income tax debt and student loans
• No formal process to stop collections and other creditor actions
• Creditors may opt out of the agreement at any time
• Does not reduce the principal value of your debts / may not be affordable based on your income
• Repayment plans typically require a four- to five-year commitment
• Reported as R7 (same as Consumer Proposal) on your credit report

When would a DMP be right for you? A DMP may be effective in situations where you have few outstanding debts, are currently in good standing with your creditors, and where interest costs are the primary cause of your financial difficulties. A DMP may also be beneficial if one or more of your creditors backing out of the DMP would not immediately jeopardize your ability to manage your monthly bills and debt obligations.

Consumer Proposal

A Consumer Proposal is a legally binding settlement with your creditors which is offered under the Bankruptcy and Insolvency Act (BIA) and may only be administered by a Licensed Insolvency Trustee (LIT). The process involves the LIT making a settlement offer to your unsecured (i.e., non-mortgage, non-automotive, etc.) creditors which you will repay either as a lump sum or monthly over a period of up to five years. This settlement is based on your income and budget and may reduce your total outstanding debt by as much as half.

Once more than 50 percent (by dollar value) of your unsecured creditors agree to accept the settlement, the Consumer Proposal is binding on all your unsecured creditors. You remit all payments directly to the LIT and they distribute the funds to your creditors until you have paid the settlement in full.

Pros

• No upfront cost
• Immediately stops collection action, interest, and garnishees
• Allows you to retain assets and income tax refunds
• Repay less than you owe
• Fixed monthly payment or lump sum payment
• May include income tax debt and student loans (in some situations)

Cons

• Majority of creditors must vote to accept the Consumer Proposal. If they reject, the LIT may submit an amended proposal, otherwise your only option may be to file a Bankruptcy
• A typical consumer proposal requires a five-year commitment. If you wish to pay a lump sum, you may need to borrow money from family or friends.
• The proposal is annulled if you miss three payments (i.e., default). The original debt is reinstated (minus payments) and creditors may resume collections action.
• Reported as R7 on your credit report and negatively impacts your credit score for three years after completion
• Some financial institutions view a Consumer Proposal as equivalent to a Bankruptcy
• Must have less than $250,000 in debt (excluding mortgage on personal residence)

When would a Consumer Proposal be right for you? A Consumer Proposal may be effective in situations where you can still afford to make some monthly payments but require help in reducing these to fit your budget. If you are at risk of or currently experiencing collections action, want a clear and certain path to debt freedom, and owe less than $250,000 in non-mortgage debt, you may benefit from a Consumer Proposal.

Bankruptcy

Bankruptcy is a formal debt solution offered under the BIA which may only be administered by an LIT. The process involves surrendering certain non-exempt assets and potentially a portion of your income to the LIT in exchange for eliminating your outstanding debts. The LIT will liquidate (i.e., sell) certain non-exempt assets and distribute the proceeds (and a portion of your income, if applicable) to your creditors on a priority basis to compensate for the debt payments they will no longer receive.

A first Bankruptcy typically lasts nine months without surplus income payments and 21 months with surplus income payments. Second or subsequent Bankruptcies typically last 24 months without surplus income payments and 36 months with surplus income payments.

Pros

• Immediately stops collection action, interest, and garnishees
• Creditors cannot refuse a bankruptcy
• LIT will often file outstanding personal income tax returns
• Process lasts either 9 or 21 months if a first time bankrupt
• No limit on the size of debt load
• Repay less than you owe

Cons

• Some assets may vest with the trustee, subject to provincial exemptions, often including principal residence (if owned / mortgaged) and automobiles
• Requires comprehensive monthly income and expense reporting
• Monthly payment requirements can fluctuate or be triggered by raises or financial windfalls
• Creditors can oppose discharge, and a court hearing may be required
• First Bankruptcy negatively impacts your credit score for seven years after discharge. Subsequent Bankruptcies negatively impact credit score for 14 years after discharge.
• Some tax refunds are turned over to the trustee

When would a Bankruptcy be right for you? Bankruptcy may be your best option in situations where your creditors are unlikely to accept a Consumer Proposal, you earn less than the federally mandated surplus income thresholds, and have few non-exempt assets to surrender. Bankruptcy may also be the only solution available to people who don’t want to wait up to five years for permanent debt relief.

Help is available to make an informed decision

Navigating a financial crisis can often feel lonely and frustrating. The good news is whatever you’re experiencing, you don’t have to face it alone. There are options to address your challenges head on and get the relief you need.

Still wondering which option is best for you? At MNP, we’ve developed a helpful Debt Calculator tool to compare the costs and timelines of each debt solution discussed above.

We also encourage anyone struggling with debt to schedule a Free Confidential Consultation with their local MNP Licensed Insolvency Trustee. These initial discussions are discrete, obligation free, and guaranteed to help you better understand your debt and all your options in depth. Our Licensed Insolvency Trustees will help you choose the right solution for you and walk you through every step of your Consumer Proposal or Bankruptcy. If you choose not to pursue a Bankruptcy or Consumer Proposal, they can also refer you to other qualified credit counselors or professionals in your area.