Debt Consolidation vs. Bankruptcy

Most people will have to tackle some form of debt in their lifetime. The key is to stay ahead of it by paying your bills on time. Nonetheless, it can be easy to take on too much debt to handle by traditional means, in which case you might need some professional help through a debt management solution. 

Two of the most effective debt relief procedures in Canada are debt consolidation and bankruptcy. Want to know the benefits and drawbacks of these two debt solutions and, if necessary, which one would be right for you? Then check out this article. 

What is Debt Consolidation?

If you have too much debt to pay off with your income or savings, one of the first solutions you could try is a debt consolidation loan or debt consolidation program. Some borrowers prefer these types of debt management procedures simply because they can be far less impactful on someone’s finances than declaring bankruptcy.  

How Does Debt Consolidation Work?

When discussing your debt relief options, it’s important to understand that there are two ways in which you can consolidate your debt.

You can borrow a debt consolidation loan from a bank, credit union or alternative lender. In most scenarios, the loan will be deposited directly into your bank account. You would then use the funds to cover your outstanding debts all at once, then repay the lender in divided installments (plus interest and fees) over several months (sometimes years with a larger loan).

You can enter a debt consolidation program through a credit counselling agency, which also involves paying down your debts via installments. However, you’ll instead give your payments to your credit counsellor, who will send them to your creditors on your behalf. The counsellor may even be able to negotiate a more affordable deal than you would have with a debt consolidation loan.

In either scenario, the goal is the same; to help you pay off your debts quickly and leave you with one payment plan to follow. Although you may have to cover your credit counsellor’s service price or loan costs, a single debt can be easier on your finances than multiple debts, rates, and fees.

Here’s an example to give you a better idea of how debt consolidation works:

• You have a credit card with $7,000 of debt and a standard rate of 21.99% APR
• Due to the size of your debt, you’ve been making minimum or partial payments
• While this can prevent penalties, you’ll pay interest on any unpaid amounts
• Then there are the card provider’s fees
• If you were to simply make the minimum payment or a fixed payment of $300 a month, you’ll be paying $10,650.33 or $2,217.21 in interest respectively. 
• Think about what would happen with multiple credit cards and interest rates  

So, instead….

• You borrow a debt consolidation loan of $7,000 with a rate of 8.4% APR
• If you’re lucky, you’ll have a fixed rate that won’t change during your loan term
• You may pay a bit more with a variable rate (fluctuates with Canada’s prime rate) 
• That loan has a set repayment term of 36 months (3 years) 
• At a rate of 8.4%, you will pay $943.34 in interest for your loan (total) and your monthly payment would be lower than the $300 at $220.65. 
• Despite the extra fees, this is still more affordable than even a single credit card

Other Ways to Consolidate Debt

Although a debt consolidation loan or program can be helpful under the right circumstances, either solution can have a significant impact on your finances and force you to take on a debt you’re not comfortable with. If that’s the case, don’t worry, there are a few less drastic ways to consolidate your debts, such as:

• Personal Line of Credit – Similar to a credit card, a line of credit involves a revolving credit limit that you can apply for through your financial institution and use to repay your debts. However, you will likely be given a special new card that you can use to conduct transactions. Be careful, as your lender may ask for collateral and you could lose your asset if you miss too many payments.

• Home Equity Line of Credit – a HELOC allows you to take out a line of credit against the equity in your home. While this can be risky as well (your home could be foreclosed if you default), you can potentially access a much larger credit limit (up to 80% of your available equity) and longer repayment term (often 10 – 20 years) if you have at least 20% equity. 

• Credit Card Balance Transfers – Some credit card providers will permit you to transfer multiple debts onto a single credit card with a lower interest rate, which can save you money and stress. That said, some hefty transfer fees and other drawbacks may apply to your particular card, so remember to get all the information you need from your provider before applying.     

What is Bankruptcy?

Declaring personal bankruptcy is a highly effective legal process that you can file for when you have at least $1,000 of debt. It clears all of your unsecured debts, often in exchange for the surrender of your assets to satisfy your creditors, allowing you to start over with a clean slate. The assets you do and don’t have to surrender may vary depending on what province or territory the process is being conducted within. 

How Does Bankruptcy Work? 

To file for personal bankruptcy, you’ll have to hire a Licensed Insolvency Trustee, who will guide you through the process and contract your debt sources on your behalf. These officers of the court are regulated by the federal government and work within the bounds of the Bankruptcy and Insolvency Act of Canada. 

Once you’re deemed eligible for personal bankruptcy and the legal process begins, any debt collection penalties, including wage garnishment, lawsuits and mounting interest should cease and the whole ordeal will become a matter of public record. Soon after, you’ll be relieved of any unsecured debts that qualify for the procedure. 

Debt Consolidation Advantages and Disadvantages 

While debt consolidation is one of the less drastic debt management solutions that you can access in Canada, it’s important to weigh its pros and cons:

Pros

• Can reduce the amount of debt payments and interest to keep track off
• Loans may come with lower interest rates than other payment products
• May reduce your credit utilization ratio, which is good for your credit score
• Making timely loan payments can also increase your credit score
• Debt consolidation programs can include free credit counselling courses 
• Less harmful to your credit and finances than other debt management solutions

Cons

• Doesn’t clear your debt (you’re still responsible for paying it off)
• You’re not guaranteed to qualify for a lower interest rate than other debt solutions 
• Credit counselling is not always free (service fees may apply to your final debt)
• Missing debt consolidation loan payments can damage your credit score
• Any credit accounts being consolidated will receive an R7 credit rating
• A lower credit rating = less creditworthiness when you apply for new credit

Bankruptcy Advantages and Disadvantages 

Despite personal bankruptcy being the most effective debt management procedure available in Canada, there are some major financial consequences that can follow:

Pros

• Can be a low-cost option compared to other debt relief solutions
• The process can be fast (you may be discharged in as little as 9 months)
• Results in a stay of proceedings (no more lawsuits, wage garnishment, debt collection calls, etc.)
• The stay of proceedings will automatically end any debt collection harassment or penalties
• Having the protection and guidance of a professional trustee can be great
• Any eligible debts will be cleared from your financial profile
• Going through it can be far easier and cheaper than being in debt for years

Cons

• You may have to make surplus income payments for several months or years
• The court’s base contribution fee can be expensive ($1,800 minimum)
• The court may seize your non-essential assets (home equity, RRSPs, etc.)
• Your existing credit accounts may be frozen (leaving you no access to credit)
• All associated accounts will receive the lowest R9 credit rating
• A record will remain on your credit report for 7 years
• New creditors, employers and landlords can see this damage when you apply
• Most secured or legal debts will not qualify for discharge

Additional Reading

Car Loans After Bankruptcy

New Online Application For Bankruptcy And Consumer Proposals

Getting A Cosigner For A Debt Consolidation Loan

Is Debt Consolidation or Bankruptcy Right For You?

It can be difficult to settle on one debt management solution when each has its own benefits and drawbacks. It really depends on your current financial situation. In the case of debt consolidation and bankruptcy, one makes your debts easier to manage, while the other relieves you of them altogether.

Consider Debt Consolidation if You… 

• Have multiple debts and wish to combine them into one payment plan
• Have the financial ability to cover all payments, interest and/or fees involved
• Don’t want your credit to be as damaged as it would be after bankruptcy
• Are worried about the possibility of losing your assets
• Prefer to avoid hiring an L.I.T. and going through a major legal process
• Would rather keep your debt problems away from public knowledge 

Consider Declaring Bankruptcy if You…

• Are unable to pay off your debts using more conventional methods
• Aren’t worried about losing your non-essential assets 
• Are able to cover any legal costs or surplus income payments assigned to you
• Are willing to perform all your court duties, such as mandatory credit counselling
• Can get by with severely diminished creditworthiness and lack of access to credit
• Don’t mind a lasting negative impact on your credit report and financial profile

Before committing yourself to either of these debt management procedures, make sure to do a lot of research, get your situation assessed by a financial professional and look over the advantages and disadvantages listed above. Although debt consolidation and bankruptcy can be very effective, they may or may not actually be right for you. 

Frequently Asked Questions

Struggling to Pay Off Your Debts?

Then a debt consolidation or bankruptcy might be the best option for you. That said, remember that the benefits and drawbacks of these debt management products can affect your finances positively and negatively. So, before you get started, speak to a Licensed Insolvency Trustee or debt counsellor to get some professional advice and a proper financial assessment.