What are my options to deal with debt?

Household debt is a major challenge in Canada. The average Canadian currently owes more than $20,000 in non-mortgage debt — and a total of about $1.70 for ever one dollar they earn.

The good news is Statistics Canada reported a significant decline in overall indebtedness in 2020. However, much of that was helped by pandemic-related governments supports and consumers having fewer places to spend their money. With rising costs through the end of 2021 and into this year — and several potential interest rate increases slated in 2022, it’s going to be challenging for many households to continue that downward trend.

Much more significant and sustainable measures are necessary for those who really want to make a significant and sustainable impact on their debt. Here we investigate five of the most dependable options and how they can help you make a meaningful impact on your debt.

• Budget and track your spending
• Apply for a consolidation loan
• Negotiate with your lenders
• Work with a non-profit credit counselor
• Work with a Licensed Insolvency Trustee

Budget and track your spending

While statistics vary, most indicate only about half of Canadians regularly use a monthly budget. Everyone has different reasons for why they don’t budget: it’s time consuming, income and expenses vary from month to month, they don’t know how, etc.

However, those who regularly commit to planning and tracking their spending also tend to spend less, have less debt, and feel better prepared to deal with life’s unplanned and unexpected events. There are several reasons why this is the case:

A budget is your plan for spending money

You have limited income, but potentially infinite places where you could spend it. A budget helps you see on paper where you:

• must spend money (e.g., rent, groceries, utilities, etc.),
• should spend money (e.g., savings, debt repayments, investments), and
• could spend money (e.g., shopping, dining out, cinema, etc.).

Rather than intuiting and estimating all these competing demands, a budget helps you prioritize each expense in a way that aligns with your lifestyle and goals — in this case, paying off debt.

A budget helps you think more clearly

The average person can hold seven pieces of information in their working memory at any given time. Consider all you regular expenses, then add the mental math required to monitor your progress — you can see how easy it is to lose track of what you’ve spent, what you need to spend, and whether you can afford this latest impulse purchase.

A budget offloads these calculations to a trustworthy spreadsheet or piece of paper. Make a purchase, write it down, subtract it from your budget. Now it’s one less thing to think about and you can be more confident in deciding whether you can afford the next potential expense.

A budget helps you measure and track your progress

Human beings are built for short term wins. We love checking things off our to-do list and moving onto the next challenge. We hate the slow and tedious work of inching toward a distant goal that could be weeks, or even years off into the distance.

A budget creates the opportunity for smaller shorter term wins by helping us set incremental goals, see our progress, and celebrate achievements along the way. This could be something as simple as reducing our heating bill by $20 from one month to the next — or significant as reducing our total outstanding debt by $500 over the previous six months.

Apply for a consolidation loan

Imagine you have five buckets of various sizes that you want to fill with water. Each bucket has a small hole in the bottom where the water slowly leaks out — some of which are bigger and others which are smaller. Every month, you’re given a set amount of water to transfer into every bucket.

This, in effect is your debt situation:

• the buckets are your creditors,
• the monthly allotment of water is your income,
• the size of the bucket is how much you owe, and
• the size of the hole in the bucket is what you’re paying in interest.

Filling all the buckets isn’t as simple as transferring an equal amount of money into every bucket every month. After all, the bigger buckets will require more water. But the buckets with the larger holes will empty faster. It’s stressful, confusing, and you never really feel like you’re doing the right thing.

A consolidation loan essentially allows you to trade in all your buckets for one big one with a smaller hole in the bottom. Now your job is easier, you can pour all your water into that one bucket every month. Not only that, but less water will leak out, allowing you to fill it up more quickly.

A couple of notes on consolidation loans

This sounds like a simple and straightforward solution. However, there are some potential challenges and pitfalls to be aware of:

1. Stop using credit — A consolidation loan will enable you to pay off various debts (credit cards, lines of credit, etc.). In practice, there’s nothing stopping you from spending on those accounts and effectively doubling your debt. You must commit to not using those accounts or cancelling the accounts outright if required.
2. Mind the interest rate — There’s no value in paying more interest than you have to. If you’re offered a consolidation loan with a 10 percent interest rate, this will reduce the cost of credit cards that are charging you 20 percent. But don’t use it to pay off debts that are charging you less than 10 percent.
3. Mind the monthly payment — Revolving credit accounts tend to have lower monthly payments because there is no set deadline to pay it off. Loans are different. Even though the interest costs are lower, the payment could be higher because you need to pay it off within three or five years. Make sure the monthly payment is affordable in your budget.
4. Will you qualify? — Check your credit report and credit score before applying for consolidation loans. You’ll generally need a credit score of 650 or higher to qualify for a favourable amount, interest rate and repayment terms. Anything less and not only will you likely not qualify, but the hard inquiry on your record will also damage you credit score.

Negotiate with your lenders

“No” is a scary word. We’ll often suffer through a lot of turmoil and uncertainty just to avoid hearing it. There’s just one problem: avoiding “no” also guarantees you’ll never get the “yes” that could make a meaningful impact on your debt.

Pick up the phone and call your creditors. Ask if they’d be willing to reduce your interest rate by a specific amount (e.g., five percent). Maybe they say no, in which case you’re no worse off than before. But they could also say yes — in which case your monthly payment would be lower, you could pay more toward the principal balance every month, and you could pay your debt off more quickly.

The conversation doesn’t have to end there either. There are plenty of alternative or follow-up questions you could ask which could similarly make a significant impact:

• Would it be possible to skip a payment, without interest and penalty?
• Can I extend the terms of my loan to lower my monthly payments?
• Do you offer a different credit card with a lower interest rate?
• Etc.

Get it in writing

Arrangements with your creditors are not legally binding. If you do get a “yes,” be clear on what that yes entails, and get it in writing. Review any documents they send you to ensure it (a) reflects the agreed terms and (b) there won’t be any negative impacts to your finances, debt, or credit rating.

Never sign anything you’re not comfortable with. And, likewise, respond in writing explicitly stating you do not accept the revised terms.

Work with a non-profit credit counselor

If you’re still uncomfortable negotiating with your creditors — or you find these negotiations to be unproductive — consider working with a skilled professionals who can do this work on your behalf.

Non-profit credit counseling agencies offer a range of services to help you better understand your debt and financial challenges, negotiate with creditors, and, in many cases, repay your debt faster.

One of the most common options is a debt management plan (DMP), whereby a credit counselor would negotiate with your creditors to reduce the outstanding interest on your debt. You would pay a single monthly payment to the credit counselor every month (up to a maximum of five years), and they would pay your creditors directly.

Credit counseling benefits

There are several potential benefits to working with a non-profit credit counselor, and MNP often refers individuals to use these services when appropriate. Some of the benefits include:

• Informed perspective on budgeting habits and cost saving opportunities.
• Advocacy with creditors / ability to negotiate reduced interest rates.
• Consolidate multiple debts into a more affordable monthly payment (i.e., DMP).

Credit counseling drawbacks

There are also some potential drawbacks to working with a credit counselor, which are important to be aware of. Some of these include:

• There is an up-front fee for many credit counseling services (even non-profit credit counselors).
• A DMP and other related services will have a negative impact on your credit rating
• You have to repay the full amount of your outstanding debt.
• Agreements with creditors are not legally binding. Creditors can choose not to work with the credit counselor or withdraw their participation at any time.
• No protection from collections action or court judgements.
• Credit counseling services are not federally regulated, and oversight varies from province to province.

Work with a Licensed Insolvency Trustee

Licensed Insolvency Trustees are regulated under Canada’s Bankruptcy and Insolvency Act and are the only debt professionals in the country who can administer Consumer Proposals and Bankruptcies. Their license includes several key responsibilities, including providing an unbiased assessment of your financial situation and an impartial opinion of which option would be most appropriate for you.

At MNP, we offer Free Confidential Consultations to all Canadian residents to review your financial situation and point you in the direction of permanent debt relief. These meetings are free of cost, you don’t have to participate in any of the services MNP offers, and you don’t have to be at a position where you can no longer afford your debts.

In fact, the earlier you contact us, the more options we’ll be able to discuss and the less likely it will be that a Consumer Proposal or Bankruptcy is in your best interest. We can discuss your budget, consolidation loans, and may even refer you to a local non-profit credit counselor.

With that said, it’s also possible a Consumer Proposal or Bankruptcy will be in your best interest — and, indeed, the fastest and most cost-effective solution for lasting debt relief.

Consumer Proposal

Through a Consumer Proposal, the Licensed Insolvency Trustee will assess your income and expenses and determine how much you can afford to pay every month. They will use this amount to calculate a fair settlement with your unsecured creditors (e.g., credit cards, personal loans, lines of credit), which you will repay either in a single lump sum payment or monthly over a maximum of five years.

If a majority of your unsecured creditors (51 percent by amount owing) votes to accept the proposal, it becomes legally binding on all your unsecured creditors. You make a single (lump sum or monthly) payment directly to the Licensed Insolvency Trustee, who then pays your creditors.

Consumer Proposal benefits:

• Repay less than you owe
• Payments are interest free
• Once accepted, unsecured creditors cannot back out or choose not to participate
• Protect assets from liquidation or repossession
• Debt collectors cannot contact you, garnish your wages, or seek a court judgement
• Clear timeline to debt freedom
• Two counseling sessions to improve budgeting credit management skills
• No upfront costs (Trustee’s fees come from monthly payments)
• No penalty for paying off your proposal early

Consumer Proposal drawbacks:

• Negative impact on your credit rating for three years after completion
• Cannot pick and choose which creditors are included
• If creditors vote against your Proposal (and a revised amount doesn’t fit your budget), you will be forced to file a Bankruptcy
• Consumer Proposal is terminated if you miss three successive payments / do not attend financial counseling sessions

Bankruptcy

The Bankruptcy process involves surrendering certain property and potentially a portion of your income in exchange for debt forgiveness and a financial fresh start. At the outset of your Bankruptcy, you will report all your debts, income, and assets to the Licensed Insolvency Trustee. They will then determine which items you can keep, which you must surrender — and what (if anything) you will need to pay into your Bankruptcy every month.

The Licensed Insolvency Trustee will liquidate (i.e., sell) any items you surrendered, and distribute any additional payments for the general benefit of your creditors. You will continue to report your monthly income and expenses to the Licensed Insolvency Trustee for the remainder of your Bankruptcy (9 months for a first Bankruptcy without payments, 21 months for a first Bankruptcy with payments).

If your creditors and the Licensed Insolvency Trustee are satisfied you have completed all your applicable duties at the end of the relevant timeframe, you will be relieved of all applicable debts covered under your Bankruptcy.

Bankruptcy benefits:

• Repay less than you owe
• Become debt free in less than two years (for a first Bankruptcy)
• Creditors cannot refuse a Bankruptcy
• Protect registered plans (e.g., RRSPs)
• Debt collectors cannot contact you, garnish your wages, or seek a court judgement
• Two counseling sessions to improve budgeting credit management skills

Bankruptcy drawbacks:

• Negative impact on your credit rating for seven years after completion (for a first Bankruptcy)
• Cannot pick and choose which creditors are included
• Must surrender assets not protected by provincial exemptions (or pay equity value to keep)
• Potentially requires additional monthly payments if income is above a certain threshold
• Increase in income (e.g., pay raise, windfall, etc.) could trigger payment requirements and extend the length of Bankruptcy
• Discharge may require a court hearing (and additional duties) if your creditors or the Licensed Insolvency Trustee objects
• Up-front cost, as prescribed by federal legislation