Home ownership is a common goal for many people, and as Licensed Insolvency Trustees we often work with individuals who are worried that using a legal debt solution to get out of debt will mean sacrificing this major future financial goal. Fortunately, credit rating impacts of even a full debt forgiveness option are only temporary; if you’re weighing how best to deal with debt against potential hits to your credit score it’s important to know that you will be able to move forward without dragging your debt’s history along with you forever.
Read on to learn about how Canada’s two legal consumer debt solutions (Consumer Proposals and personal bankruptcy) can be useful steps in helping you achieve future goals like home ownership, comfortable retirement and more.
What is the Credit Impact of Declaring Bankruptcy or Making a Consumer Proposal?
Understanding the real-life pros and cons can help people make better decisions about how to resolve financial challenges they may be facing in dealing with debt and remove anxieties about the future too.
If you’re struggling on whether it’s ‘worth it’ to temporarily reduce your credit score in exchange for a substantial reduction in your debt load, it can be helpful to first understand just what the impacts to your credit history will be for either solution. Additionally, neither option actually prevents you from seeking new credit prior to the credit history notes expiring.
A Consumer Proposal is a special consolidation option that allows you to combine virtually all of your debts into one (usually monthly) repayment plan where you will offer to repay the amount you can afford to your creditors, and they will agree to write-off the unpaid balance.
- Filing a Consumer Proposal allows you to access consolidation and avoid bankruptcy without having to borrow or pay additional service fees. Your creditors will be barred from contacting you for payments or adding interest charges to your debts.
- In BC making a Consumer Proposal and the accounts satisfied through it will come off your credit history three years from the date you completed your Consumer Proposal, or six years either from the date you filed it (Equifax), or from the date you defaulted on the account (TransUnion) – whichever comes first.
The Consumer Proposal Takeaway: You might repay as little as 20-50% of your total debt over a period up to five years, with a credit note removed the lesser of three years from completion or six years from the start.
Declaring personal bankruptcy is another legal solution that allows you to potentially have full forgiveness for all your debts should you find yourself unable to continue making your payments.
- Most people complete personal bankruptcy and receive an automatic discharge in nine months, retaining all their assets and paying a straight-forward administration fee of approximately $2,300.
- In BC personal bankruptcy and the accounts reported as included in that bankruptcy will be removed from your credit bureau file six years from the date you were discharged (released) from bankruptcy.
The Bankruptcy Takeaway: You might pay $2,300 over nine months to have virtually all your debts forgiven, with a credit note removed six years plus nine months after bankruptcy started.
Legal debt solutions aside, most accounts with ‘adverse’ credit history (i.e. NSFs, collections, judgments, etc.) will be shown on your credit bureau file for six years after the date you defaulted on the account.
- Debts reported as paid through an informal credit counselling program will be removed two years from the date your program is satisfied, or six years after the date you defaulted on the account (whichever comes first). It’s important to note that you usually need to pay those accounts off in full to consider them settled with your creditors.
The Informal Approach Takeaway: You repay 100% of your debts plus the continually added interest (and/or added program fees for credit counselling), with credit notes removed six years from the date you defaulted.
Clearing your debt with a Consumer Proposal or by completing a personal bankruptcy can be the first key step in building a credit history favourable for lenders and creating healthy credit habits that will sustain your finances in the future. The financial fresh start of a legal debt solution means that many people can get out of debt and into a positive financial position faster through doing a Consumer Proposal or bankruptcy than by continuing to try to pay off their debts informally on their own.
Getting a New Mortgage After Bankruptcy or a Consumer Proposal
Yes – it is possible to qualify for a new mortgage after filing for bankruptcy or making a Consumer Proposal. You can apply for credit (mortgages, vehicle financing, credit cards, etc.) at any time, but it is highly recommended that you complete your Consumer Proposal or bankruptcy before taking on any substantial new credit. There are also a few important things to know if this is one of your goals:
- Mainstream mortgage lenders may approve a new mortgage at standard lending rates if it has been two years since you finished your Consumer Proposal or bankruptcy.
- Although sub-prime lenders may approve you for a mortgage sooner than standard lenders, carefully consider if the cost of less favourable terms is worthwhile instead of waiting until you qualify for ‘best rates’.
- Your credit history should no longer reflect over-extended debt, and you should also take steps to:
- Accumulate a down-payment
- Check for and resolve any errors on your credit bureau files
- Demonstrate responsible credit use with new established credit accounts
- Keep borrowing limits low to maintain a good ratio to your income, and always make all your payments on time.
Lenders also may consider whether you demonstrate other positive markers such as:
- Earning a steady income
- The length of time you have been at your current address
- Having savings and other assets
Credit scores change over time and getting your financial house in order to qualify for a new mortgage at best rates is something that simply takes time for most consumers, whether they’re trying to qualify for a mortgage after bankruptcy or otherwise. Doing so without the added pressure of other debts can make all the difference in whether you can be approved for new credit and comfortably satisfy this new obligation.
- There is no such thing as ‘fast-tracking’ or quick credit score repair. Companies that advertise these services are often seriously inflating their abilities. Buyer beware!
Qualified financial counselling is provided as part of both Consumer Proposal and personal bankruptcy processes in Canada, giving you the opportunity to get one-on-one expertise and resources for credit best practices and other financial literacy topics.
71% of consumers polled said their experience receiving professional debt help allowed them to improve their budgeting and/or savings skills; 59% said they had more confidence in daily financial management.
Can I Renew my Mortgage During a Bankruptcy or a Consumer Proposal?
An ongoing mortgage that you intend to continue paying on is not normally considered in the debts that will be wiped out through personal bankruptcy or making a Consumer Proposal. Because most bankruptcies and Consumer Proposals are used to deal with unsecured debts only, having declared bankruptcy or made a Consumer Proposal does not normally impact the mortgage renewal process should yours come due during (or after) your bankruptcy or Consumer Proposal, assuming that your mortgage has been paid up to date as per your borrowing terms.
A Consumer Proposal or personal bankruptcy may conversely be used as a solution to resolve unpaid balances from secured debts where the securing asset has been surrendered or seized, such as a mortgage foreclosure or a vehicle lease shortfall.
How Filing for Bankruptcy or Making a Consumer Proposal Can Help with Future Credit
Despite the short-term credit impact of a legal debt solution there can be substantial benefits in the immediate term as well as for future borrowing, including:
- Resetting your credit history
- Rebalance debt-to-income ratios
- Wipe out ongoing ‘adverse’ transaction notes
- Establish positive credit history
- Stopping the ongoing cost of debt’s added interest charges.
- Freeing up room in your budget to build savings and/or meet your costs of living more comfortably.
Once your debts have been cleared, it can be much easier to address other financial priorities that may have been put on the back burner as you focused on paying off debt. Even if a down-payment on a home isn’t a goal for you, it is still highly beneficial to accumulate a comfortable amount of personal savings.
In addition to maintaining an emergency savings account, you may want to consider other financial goals, often made more achievable with the absence of debt payments, such as:
- Purchasing a new vehicle
- Saving for a vacation
- Assisting dependents with post-secondary education costs
- Financing retirement
- Inheritance planning
There are a lot more ways to use your money well without the burden of debt payments!
When is it Better to File Bankruptcy or Make a Consumer Proposal Rather Than Pay my Debt?
No two people’s situations are exactly alike, and it’s important to understand and consider all of your options to deal with debt so you can make the decision on how move forward in the way that’s best for you and your goals.
Try the “Rule of 60” Quick Debt Repayment Math
- Add up your total unsecured debt and divide that number by 60.
- Consider whether this calculation gives you a number that looks consistently affordable as a payment for you each month to pay off all your debts within the next five years (60 months).
If yes, then you can consider what budget shifts or other self-directed strategies may be needed to help you achieve this goal. Otherwise, you may want to consider an option like a Consumer Proposal that will allow you to cut your debt down to what you can afford to pay each month, to get to debt-free within five years (or less). Or if you are in a situation where you are unable to afford any monthly payment, bankruptcy may be a more suitable option to consider.
- Most people prefer to avoid declaring bankruptcy if possible, and in many cases a Consumer Proposal can be achieved to allow you to establish a clear repayment plan, while still cutting debt down to an affordable repayment.
- This ‘best of both worlds’ gives consolidating Consumer Proposals significant advantages over traditional consolidation loans, mortgage refinancing, as well as bankruptcy.
You don’t have to make these decisions alone. If you’re unsure what to do about your debt don’t hesitate to connect with a local Licensed Insolvency Trustee in your community. In less than an hour we can work with you to create a personalized debt-free plan tailored to your needs.
Sands & Associates offers a full suite of legal debt help services, including Consumer Proposals to creditors and personal bankruptcy assistance. Book your free confidential virtual or in-person consultation with a local debt help expert today.