When dealing with overwhelming debt, there are two more drastic options you may want to consider, consumer proposals and bankruptcy. These are legal processes, administered by a License Insolvency Trustee (LIT), designed to help you manage and eliminate unsecured debts like credit cards, bank loans, payday loans, tax debt, and more. It’s important to note that secured debts, such as mortgages or car loans are not covered by consumer proposals or bankruptcy.
Generally speaking, a consumer proposal allows you to keep more of your assets and may have a lesser impact on your credit score, while bankruptcy wipes out debt faster. Your choice will depend on various factors, including the types of debt you have, your financial situation, your long-term financial objectives, and the advice you receive from your LIT. This guide will provide a detailed comparison of consumer proposals and bankruptcy in Canada. Understanding these options will help you determine the best way to address your debt issues.
At A Glance: Consumer Proposal vs. Bankruptcy
| Factor | Consumer Proposal | Bankruptcy |
| Cost | Based on what you can afford to pay back | Fixed fees set by the government, with potential surplus income payments |
| Requirements | $1,000 to $250,000 in unsecured debt (excluding mortgage) | Minimum of $1,000 of unsecured debt, no upper limit |
| Assets | Keep all assets | Liquidate assets except for exempt assets like household items |
| Length | Up to five years | 9-21 months |
| Credit Impact | Up to six years on credit report | Six to seven years on credit report |
| Monthly Payments | Fixed payments based on the agreement with your creditors | Vary based on income |
| Tax Refund | Keep tax refunds | Lose tax refunds |
What Is A Consumer Proposal?
A consumer proposal is a negotiated settlement between you and your creditors where you pay back a percentage of your debt under new terms. It must be administered through a Licensed Insolvency Trustee. To qualify, your debts must be under $250,000, excluding your mortgage.
A consumer proposal offers several advantages for those dealing with financial challenges. It eases the burden of high monthly payments, allowing you to maintain ownership of essential assets like your home, car, and retirement savings. Additionally, it provides relief from interest charges and the legal complexities of creditor disputes, helping you regain financial stability more swiftly than bankruptcy.
Acknowledging that consumer proposals carry specific drawbacks, such as a prescribed maximum five-year repayment is vital. They typically linger on your credit report for up to 6 years. The impact on your credit score, however, varies from person to person, as everyone’s credit score responds differently.
Weighing these pros and cons can help determine whether a consumer proposal is the right financial path for your situation. Here’s a step-by-step breakdown of how the consumer proposal process typically unfolds:
- Your LIT will review your financial situation, including income, assets, and debts.
- They will negotiate with your creditors to reduce your debt repayment. Often, creditors will agree to lower interest rates or waive fees.
- You agree to repay a portion of debt (usually 30-80%) over a set period of up to five years.
- Upon approval, your creditors are legally prevented from pursuing further legal actions against you regarding the reduced debt.
What Is Bankruptcy?
Declaring bankruptcy is a legal process where your assets are used to pay back debt. Then, the remaining debts are eliminated. A Licensed Insolvency Trustee handles the bankruptcy process.
To be eligible for bankruptcy, you need to have a minimum debt amount of $1,000 and be in a state of insolvency, unable to meet your debt obligations. There is no maximum limit on the amount of debt to qualify for bankruptcy.
Bankruptcy offers several advantages, including the potential to achieve debt-free status in under two years, and a halt to creditor harassment and legal actions. It also provides protection for essential assets such as clothing, food, and a vehicle up to a certain value. However, the protected assets are defined by each province. Bankruptcy lets you start rebuilding credit within six to seven years.
Nevertheless, it’s essential to weigh these benefits against the potential drawbacks. Two notable cons are the lasting impact on your credit score and the possibility of losing some non-exempt assets like family heirlooms or a second vehicle through liquidation. Here’s a simplified overview of how personal bankruptcy operates:
- In this process, you’ll transfer all your assets to the trustee, excluding exempt items like essential clothing and basic household belongings.
- The trustee will sell non-exempt assets to generate funds for repaying your creditors. However, there might be options to retain certain assets by agreeing to manageable payment plans.
- Any outstanding unsecured debt, such as credit card balances, is discharged, meaning you’re no longer obligated to repay those amounts.
- You’ll pay the trustee over 9-21 months based on your income and financial situation. This may include surplus income payments if you’re income increases during the process.
- Once the bankruptcy is discharged, creditors are legally prohibited from pursuing you for the previous debts you owe them. This is enforced by the Bankruptcy and Insolvency Act.
Comparing The Costs Of A Consumer Proposal And Bankruptcy
| Cost Comparison | Consumer Proposal | Bankruptcy |
| Determination of Cost | Tailored based on your financial situation | Minimum base cost that increases with surplus income, and asset liquidation |
| Repayment Amount | Usually 30-80% of the original debt | $1,800 minimum, increases with income, family size, and assets |
| Payback Period | 60 months – maximum | 9-21 months |
| Interest Accumulation | Stops accumulating when you file | Stops accumulating when you file |
| Flexibility in Payment Structure | Yes | No |
What Is The Cost Of A Consumer Proposal?
With a consumer proposal, you are expected to repay 30% to 80% of the original debt. You’ll work with a Licensed Insolvency Trustee to negotiate this amount with your creditors. Your LIT charges various fees that are baked into your monthly payment. They include:
- Filing fee: $104.24
- Counselling fees: $170.00
- 5% tax on counselling fees: $8.50
- Initial LIT fees: $1,500 (Two payments of $750)
- 5% tax on LIT fees: $75
Your LIT initially deducts these fees before sending any money to your creditors. Out of the amount sent to creditors, your LIT charges additional fees, such as another 20% fee, a 5% tax on this fee, and a 5% levy on creditor distributions. These fees are rolled into your monthly payment. You can reduce your monthly payment by extending up to the maximum 60-month payback period.
What Is The Cost Of A Bankruptcy?
The minimum bankruptcy cost is $1,800, commonly split into nine monthly payments of $200. However, this can increase with various factors. There are three main categories of bankruptcy costs: the base contribution, surplus income, and the assets you can lose to cover debts.
Base Contribution Cost
The base contribution cost covers administrative fees and trustee compensation. For a first-time bankruptcy, the minimum you can expect to pay is $1,800, often paid in nine monthly installments of $200. However, this cost can increase based on surplus income and your assets.
Surplus Income
You must pay surplus income fees if your earnings exceed a threshold. The government establishes the threshold every year, and it increases with family size. If your family is larger, your surplus income threshold increases. This lets you keep more income to maintain a reasonable standard of living.
In 2023, the monthly limit for a single-person household was $2,543. Any income above this amount is considered surplus income. For example, if you earn $3,143 per month, your surplus would be $600. You’d need to pay 50% of the surplus income for a monthly cost of $300.
Notably, exceeding surplus income thresholds increases your bankruptcy payback period. If it’s your first bankruptcy and you fall below income thresholds, your payback period will be nine months. However, first-time filers with surplus income must make payments for 21 months.
In some instances, if surplus income is likely, your trustee may recommend considering a Consumer Proposal as an alternative to personal bankruptcy.
Asset Cost
Bankruptcy costs include the assets you lose to pay off debts. While each province has a list of exempt assets, some overlap exists. Initially, you’ll lose your tax return for the filing year and any returns you haven’t received yet. Next, you’ll lose RRSP contributions made within the last 12 months and potentially all your other investments. You can lose equity in your home and any non-exempt vehicles, depending on your provincial exemptions.
How Does A Consumer Proposal Or Bankruptcy Impact Your Assets?
When considering debt relief options, it’s essential to understand how they impact your assets. In a consumer proposal, you can retain all your assets, including your house, vehicle, retirement savings (RRSPs), furniture, and even tax refunds. The trustee overseeing the proposal won’t seize any of these assets, and they won’t be liquidated to settle your debts.
In contrast, a bankruptcy scenario involves using non-exempt assets to repay creditors. The good news is that every province has exemption rules in place to allow you to keep essential assets. These exemptions typically cover items like clothing, essential household furnishings, a lower-value vehicle (often valued between $3,000 to $7,117), a portion of your home’s equity (usually ranging from $10,000 to $40,000, depending on your province), a portion of your RRSPs (up to $20,000), and tools for work (up to $10,000 – $31,379).
However, non-exempt assets must be surrendered unless you arrange to repurchase them from the trustee. Understanding these differences is crucial when weighing your debt relief options.
How Long Does a Consumer Proposal Take?
Consumer proposals offer more flexibility in terms of the duration of the debt repayment plan, typically ranging from one to five years, with a maximum period of five years. The process generally begins with a 1-2 week preparation phase, followed by a formal filing and notifying creditors within five business days. Creditors have 45 days to vote on the proposed repayment terms. If accepted, you make monthly payments according to the agreed-upon plan.
- Preparation (1-2 weeks): The Licensed Insolvency Trustee prepares the consumer proposal based on your financial situation and proposed repayment plan. They will gather information, review your debts and assets, and draft the proposal.
- Filing the Proposal (Day 1): The trustee formally files the consumer proposal paperwork with the Office of the Superintendent of Bankruptcy. This official filing puts the process into motion.
- Notifying Creditors (Within five business days of filing): Within five business days of filing your proposal, the trustee must inform all the creditors of the filed proposal.
- Voting Period for Creditors (45 days): Once notified, your creditors have 45 days to decide whether to accept or reject the proposed repayment terms.
- Monthly Payments (1-5 years): If accepted, you begin making the monthly payments outlined in the proposal. Most proposals have payment terms ranging from 1-5 years, with five years being the maximum allowed duration.
How Long Does A Bankruptcy Take?
Bankruptcy follows a more structured timeline, with a duration of 9-21 months for first-time bankruptcies. The process includes a 1-2 week consultation and preparation phase, a formal filing, creditor notifications, asset liquidation, and income payments for the specified period. Bankruptcy also involves the possibility of objections that can delay the discharge until they are resolved. Here is a general timeline of the bankruptcy process.
- Consultation and Preparation (1-2 weeks): Meet the trustee to review your financial situation and prepare the necessary bankruptcy documentation.
- Filing the Bankruptcy (Day 1): The trustee files the bankruptcy paperwork, initiating the legal process.
- Notifying Creditors (Within five business days): All known creditors must be notified of your bankruptcy within five business days.
- Asset Liquidation & Income Payments (1-21 months): You make monthly payments to the trustee based on your income for 9-21 months in most bankruptcies. First-time bankruptcies can be discharged after 9 months of payments or 21 months if you need to make surplus income payments. Any non-exempt assets identified are liquidated, and proceeds are paid to creditors.
How Do Consumer Proposals And Bankruptcies Impact Your Credit Score?
Both a consumer proposal and bankruptcy will have a similar but slightly different impact on your credit report.
Impact Of A Consumer Proposal On Credit Score
A consumer proposal will remain on your credit bureau reports for three years from completion or six years from filing, whichever is earlier. Each account associated with the proposal will receive an R7 rating. Most lenders will not approve new unsecured credit like credit cards during your proposal. After completion, you can start rebuilding credit.
Impact Of A Bankruptcy On Credit Score
Bankruptcy remains on your credit reports for 6-7 years, depending on your province. Each account associated with the bankruptcy will receive an R9 rating. Any new credit application will likely require a co-signer or secured collateral during those 6-7 years.
What are the Monthly Payments for Consumer Proposals and Bankruptcies?
When it comes to handling your monthly payments in Canada, it’s vital to grasp the distinctions between a consumer proposal and bankruptcy.
Consumer Proposal Payments
In a consumer proposal, your monthly payments are determined by the debt you’ve agreed to repay. The essential advantage here is the predictability of fixed costs throughout the term, regardless of any increases in your income.
Bankruptcy Payments
When you file for bankruptcy, your Licensed Insolvency Trustee (LIT) will initially require you to pay a monthly base contribution, typically starting at $1,800 ($200 per month for 9 months). Any additional fees or surplus income payments are determined by federal legislation and depend on your individual circumstances.
The fixed nature of Consumer Proposal payments stands in contrast to the variable costs in Bankruptcy, underscoring the importance of selecting the option that best aligns with your financial stability and goals.
What Happens To Tax Refunds During A Consumer Proposal vs. Bankruptcy?
You retain your tax refunds in a consumer proposal, provided you don’t have outstanding taxes. However, if you have tax debt, the Canada Revenue Agency will withhold a portion of your refund to settle those obligations.
Conversely, when you file for bankruptcy, you forfeit your tax refunds for the year you filed and any refunds coming in from the previous years. Even if you amend your tax returns these refunds are directed to the bankruptcy trustee.
Consumer Proposal vs. Bankruptcy: How To Choose The Right Debt Relief Option
Deciding between a consumer proposal and declaring bankruptcy can take time and effort. While both provide legal protection from creditors you can’t repay, there are key differences you need to weigh.
When A Consumer Proposal Is Ideal
A consumer proposal is designed to work for you by allowing you to repay a portion of your debt over an extended period. Generally, a consumer proposal is your best choice if you want to:
- Safeguard essential assets like your house, especially if it holds equity.
- Have a clear and manageable payment plan with fixed monthly amounts that fit your budget comfortably.
- Begin rebuilding your credit faster than through bankruptcy.
When Bankruptcy Is Preferable
Bankruptcy, on the other hand, can be a faster path to being debt-free. It might cause disruption, but it gives you a fresh start in under two years, wiping away your eligible debt through asset liquidation and discharge. This might be the best route if:
- You find yourself with minimal assets to protect.
- You’ve experienced a job loss, or your income has significantly decreased.
- Your income is not high enough to even cover a portion of your debts.
- You owe tax debt that isn’t included in consumer proposals.
- Your top priority is the quickest way to become debt-free.
The decision ultimately depends on what’s best for your unique circumstances. To make an informed choice, reach out to a Licensed Insolvency Trustee. They’ll dive into your complete financial picture and debt situation, guiding you on whether a consumer proposal or bankruptcy aligns with your financial goals.
Alternatives To A Consumer Proposal Or Bankruptcy
It’s essential to exercise caution when considering ways to reduce your debt. While a consumer proposal and bankruptcy can help absolve you of your debts, they can have a huge impact on your credit and finances.
Before applying for such extreme debt relief services, consider these other options when your debt becomes too much:
Debt Management Program (DMP)
A debt management program involves working with a credit counselling agency to develop a structured plan to pay off your debts. The agency negotiates with your creditors for lower interest rates and a consolidated repayment plan, making it easier for you to manage and pay your debts over time.
Debt Consolidation Loan
A debt consolidation loan is a loan that allows you to combine all your existing debts into a single, larger loan with a fixed interest rate. This can make it easier to manage your debt by having a single monthly payment and potentially reduce your overall interest expenses compared to paying multiple debts separately.
HELOC
Homeowners can benefit from lower interest rates through a home equity line of credit. You can think of this as a credit card tied to your home equity. Since the loan is secured to your home, you’ll generally have the lowest rates. Similar to debt consolidation, you can refinance debt to a lower interest rate and have one payment. However, consistently failing to make payments can result in your lender foreclosing your home.
Sell Assets
Selling assets you own, such as extra vehicles, property, or recreational items, can generate funds to pay down your debt. It’s important to evaluate which assets are not essential and can be sold without significantly impacting your daily life.
Bottom Line
Choosing between a consumer proposal and personal bankruptcy in Canada requires careful consideration of your financial circumstances and priorities. A consumer proposal allows you to safeguard your assets and provides a structured repayment plan over a set duration. On the other hand, bankruptcy expedites the process of resolving debts but substantially impacts your credit history.
