It’s in your best interest to stay out of debt whenever and however you can. Unfortunately, no kind of debt can be swept under the rug, whether it’s from your credit cards, mortgage, car payments, payday loans, or otherwise.
Being responsible by paying your bills on time and in full should help you steer clear of any lasting damage to your finances or credit. On the other hand, being irresponsible by making late or short payments, missing them altogether or not honoring your loan agreement in any way is known as “defaulting”, a situation you should try to avoid. As strong as your credit and finances may be at the moment, it’s still good to learn about the consequences of defaulting, just in case you ever suffer the long-lasting effects that severe debt can cause.
Secured vs. Unsecured Debt
Firstly, you need to know about the two kinds of debt you’ll see as a borrower. For each type of debt you add to your repertoire, the effects of defaulting may differ slightly.
“Secured” debt means it’s attached to one of your assets, such as your car, house, or any other piece of property that’s of significant value, similar to a security deposit. This is otherwise known as “collateral”, which creditors will request as compensation for the risk they’re taking by lending you money. Secured debt might not be the most common type in Canada, but the fact that it’s weighed against your property makes it extremely important to learn about.
Consequences for Defaulting on Secured Debt:
Since your debt is secured against your asset, if you default, your creditor can put a lien on it, which gives them the right to foreclose on or repossess it, meaning you could lose your house, car or other property. While your creditor may give you a short grace period to pay them back, if they think you aren’t going to, they may sell your asset as partial reimbursement for their loss. If the asset doesn’t bring the full sum of your debt when it’s sold, the creditor may continue to pursue you for the remainder of the debt owed.
To learn about the foreclosure process in Canada, click here.
Consider these consequences before you apply for any form of secured debt. Not only will your property be taken away, your creditor will report your delinquent activity Canada’s credit reporting agencies (Equifax and TransUnion), which can damage your credit badly. That damaged credit can prevent you from obtaining any future assets or credit products until you manage to repair it. Remember, if you’re paying for your assets using credit, you do not own them straight away. Your creditor holds the rights to the property until you pay for it completely.
“Unsecured” debt is more common, partly because it doesn’t involve assets. While not everyone can afford a mortgage or a car loan, most people over the age of 18 have a credit card these days. Credit cards are the most widely used form of unsecured debt, along with lines of credit, personal loans, etc.
Credit cards and lines of credit are types of revolving debt.
Consequences for Defaulting on Unsecured Debt
Because there’s no collateral involved, you might think the consequences for defaulting on your unsecured debts won’t be as severe as your secured ones. Don’t get ahead of yourself! Even though it might sting to have your house foreclosed or your car repossessed, these repercussions may only affect you for a certain time. You can get new assets someday if you improve your finances and credit. On the other hand, continual unsecured debt can trap you in a cycle of unpaid bills for years, potentially the rest of your life, especially when you factor in penalties and interest fees.
For a better look at secured and unsecured credit, click here.
What Your Debt Timetable Will Look Like
All this being said, don’t be afraid of using credit products. In fact, they can help you in many ways, as long as you’re handling them properly. Good long-term credit usage raises your creditworthiness, giving you better odds of approval for more expensive credit products later on, such as mortgages. However, it’s still important to learn what happens when you don’t handle them responsibly, just in case.
Event # 1 – You Rack Up Debt
Debt doesn’t just magically appear (unless you’ve somehow fallen victim to identity theft). Let’s say you activate your first credit card and use it. Maybe you take out a loan or use another financial product that requires you to make regular payments toward a creditor. When you use that loan money, you’ll be in debt until you manage to pay said creditor back in full.
Racking Up Secured Debt
Your creditor will now give you a scheduled timeframe within which you’ll have to reimburse the money you owe. Secured products are usually more expensive, so the full loan will be separated into regular payments, making it more affordable. The payments could be weekly or bi-weekly, monthly or bi-monthly, etc. If you miss a payment, you’ll be charged a penalty fee, but your creditor may also give you a grace period to repay them. However, if this behaviour continues, your asset might be seized.
How to avoid this: Contact your creditor and explain why you defaulted. Together, you should be able to negotiate a more reasonable payment plan.
Want to know how your payment history affects your credit score? Find out here.
Racking Up Unsecured Debt
With unsecured debt and revolving credit products, you’ll most likely be given a 30-day payment period, as you would see with your monthly credit card statements. The creditor will also offer a minimum monthly payment for each billing cycle. As long as you at least make this minimum payment from month-to-month, you’ll avoid a penalty fee. However, you’ll be charged interest for every dollar that goes unpaid.
How to avoid this: Pay your bills in the fullest amounts possible and never miss a payment date. When you forget a payment, contact your creditor. If you’ve been a responsible client so far and agree to pay your bill in full, they may waive the penalty fee and interest charge. If you’ve got the necessary finances but you keep forgetting, set up automatic payments through your bank.
Event #2 – You’re 30 Days Overdue
Maybe you don’t have the necessary resources to pay your bills, so you skip one payment and you’re now an extra 30 days past your original due date.
When your debt is secured and you’re a month or more overdue, your creditor will start by reporting your delinquent activity to the credit bureaus. A record of this will remain on your credit report for up to 7 years and your credit score will gradually drop. From this point on, you’ll be running a greater risk of having your asset seized.
Again, the consequences for defaulting on unsecured debt won’t be as severe at first. You’ll be charged another late penalty and your interest rate may go up. However, no asset will be seized and no legal actions will be taken against you.
How to avoid this: In both cases, your creditor will try to contact you by phone or by mail, asking for payment. If you avoid these notices, they might think that you’re attempting to dodge your payments. Respond promptly. Explain the situation and assure them that you’re capable of paying. If they agree, you might be able to work out a more reasonable payment plan.
Here’s how you can rebuild your credit after a late payment.
Event #3 – You’re 60 Days Overdue
With both secured and unsecured credit products, the consequences will vary depending on your creditor’s specifications and the amount of money you owe.
However, in most cases, another late fee will be added to your account and more payment demands will arrive. Your creditors will report to the credit bureaus that you’re now 60 days late, causing another drop in credit score and credit rating, followed by another notice in your credit report. The bureau may add an “internal collection status” to your account, meaning the creditor is still temporarily attempting to collect payment.
How to avoid this: At this point, you may still be able to negotiate a payment plan or a reduced payment, as long as your creditor can determine that you’re actively trying to pay them back.
Event #4 – You’re 90 Days Overdue
This is when you’ll really be getting into hot water. Your bills will continue to pile up and your delinquent activity will again be reported to the credit bureaus, making your credit status worse. If you’re still avoiding your creditors, the situation will continue downhill.
Your creditor will be on the verge of seizing your assets. By now, it’s also probable that they won’t accept partial payments, meaning you’ll have to make all 3 months worth of payments immediately, including interest and penalties, or face the consequences. If it’s a mortgage, they’ll begin the foreclosure process. If it’s a car, repossession.
Your creditor will warn you that you’ll soon be placed in “charge-off” status, meaning your unpaid credit accounts will be frozen. They’ll also contemplate selling your debt to an external collection agency.
How to avoid this: Contact your creditor immediately and try to negotiate a payment plan. If that option is off the table, negotiate a debt management program. If they accept the program, your full debt balance could potentially be lowered. However, not all creditors will agree to these programs, at which point you may have to consider more drastic options, such as a debt consolidation loan.
Read this for some information about debt consolidation.
Event #5 – Asset Seizures and Collection Agencies
Your creditor will now label your account as “uncollectible”. They’ll inform the credit bureaus that you’re more than 90 days overdue and your account will be put in charge-off status. Be warned, this doesn’t mean you’re out of the woods.
If you still haven’t paid by now, there’s not much you can do to avoid having your property seized. Your creditor will then try to sell your property at auction. As mentioned, if the asset doesn’t sell for the full loan amount, they may continue to pursue you for the remaining balance, the effect of which is similar to both secured and unsecured debt.
Your debt will now be sold to a collection agency, a third-party company, who are likely to use less polite tactics to get you to pay. By selling, your creditor won’t receive nearly as much as your debt is actually worth. However, they would prefer to get at least a portion of their money back, rather than nothing.
The collection agency will start by contacting you at home. Know your rights, because there are certain tactics that collection agents are not legally allowed to use, such as:
- Threatening or abusive language
- Lying about the debt amount, who they are, or any legal ramifications
- Lying about whether the Statute of Limitations has passed (timeframe within which they are allowed to take legal action against you)
- Calling you before 8 a.m. or after 9 p.m.
- Calling you at work if you’ve already denied them permission
- Informing your friends, family, colleagues/employer, or neighbors about your debt (they may call them to ask for your contact information)
- Continue contacting you after you’ve requested that they stop
Again, be very cautious when dealing with a collection agency. Just because you’ve requested that they stop contacting you, it doesn’t mean that they’re going to give up. Actually, avoiding them may only make things worse, especially if your debt is large enough to warrant a lawsuit. It may take a long time. They may even contact you for a debt that’s been unpaid for years, otherwise known as a “zombie debt”. If that Statute of Limitations has already passed by that point, this is a clever tactic they can use to reset it, hoping that you’ve forgotten. If you pay a single dollar of this ancient debt, the Statute resets itself and they can sue you all over again.
How to avoid this: You may be able to set up a payment plan or pay your debt all at once through their agency. If you negotiate, they may even allow you to settle for less than you owe. However, not all collection agencies will agree to this.
Need to know how to stop collection harassment in Canada? Try this.
Event #6 – You’re Under Threat of Legal Action
If the collection agency still can’t collect your debt and the Statute of Limitations hasn’t passed, they may decide to sue you. The Statute can last for 2-6 years, depending on what province you live in. Since court cases can be long and expensive, some agencies might forgo this process, unless your debt is large enough to justify the effort.
Months, maybe even years after you initially refuse to pay, you’ll receive a subpoena to appear in court at a certain date and time. Do not ignore this summons! Debt collection agencies would rather you didn’t show up because it means you’re not going to fight them or pay your debt. If that happens, the judge will pass a default sentence, giving the agency the legal right to garnish your wages by freezing your bank accounts or forcing you to set up automatic payments. They may put a lien on your assets (if the debt is secured). Afterward, your credit will be in shambles.
To learn more about the debt collection process in Canada, click here.
How you can avoid this: Show up to your hearing on time and prepared. Hire a lawyer if you can afford one. If your case is solid and there was a good reason for you defaulting, you may be able to fight the lawsuit internally and get your debt reduced or establish a payment plan. Either way, it’s best to act sooner rather than later.
Dealing With Your Debt For a Better Financial Future
While a little bit of debt might not ruin your credit and finances, having a lot of it and letting it get unmanageable certainly can. That’s why it’s important to pay down your debt, on schedule, however you possibly can. To discover how we can help you better manage your debt, contact us today.