By Tom Drake on April 23, 2020
Some debts cannot be discharged in bankruptcy. There is a common myth that if you declare bankruptcy, all of your debts magically go away. Not only is this inaccurate, but bankruptcy also may not be your best option for debt relief. Before deciding on how to deal with creditors and unpaid bills, it’s essential to understand what debts you can include in bankruptcy, and which ones aren’t. Knowing this will help you settle on a debt recovery solution that’s right for you.
After more than a decade of low interest rates, Canadians continue to pile on consumer debt. Unfortunately, this leaves many individuals and families highly leveraged, with little wiggle room should their income suddenly be interrupted. The resulting financial fallout can be disastrous.
For October 2019, the Office of the Superintendent of Bankruptcy reported that total insolvencies in Canada exceeded 13,200. This represented the highest monthly total in over a decade. Amongst insolvencies, bankruptcies remained relatively flat versus the same period in the previous year. However, consumer proposals, which are a bankruptcy alternative, jumped by over 20% during the same period.
Consumer proposals now outnumber bankruptcies in Canada, making up almost 60% of total insolvencies in 2019. A Licensed Insolvency Trustee may tell you consumer proposals do not require you to surrender valuable assets such as your home or vehicle. That isn’t the case with bankruptcy, which is why it’s considered a last resort. Speak to a bankruptcy trustee for more details about your finances.
How Bankruptcy Works
Simply put, bankruptcy is a legally binding agreement that releases you from your unsecured debt. In other words, bankruptcy does not cover secured debts, such as a mortgage, or an auto loan. The bankruptcy process requires the debtor to surrender their assets to an insolvency trustee, who then sells them to pay off creditors. So, for someone who has substantial assets, yet funds themselves unable to stay on top of their debt, bankruptcy may not be the right solution.
Debts Not Discharged in Bankruptcy
While bankruptcy can release you from your unsecured debt, such as credit card debt, unsecured loan debt, and lines of credit, here is a list of debts you cannot include in bankruptcy. Review the different types of debt below.
You cannot include your mortgage in bankruptcy. Because bankruptcy involves the surrendering of assets (with exceptions) in exchange for a release of unsecured debts, you could actually lose your home if you had considerable equity built into it when you file.
If you have a secure vehicle loan, you cannot include it in a bankruptcy filing. As with your home, you may have to surrender your vehicle if the value far exceeds what is owing on the car loan.
If your wages are being garnished for child support or alimony, it will continue and cannot be part of the bankruptcy.
Child Support or Alimony
Further to the above, any lump sum or future child support or alimony payments owing will remain.
Student loans cannot be included in a bankruptcy if it’s been less than seven years since you were a student. They consider it if you’ve been out of post-secondary school for more than seven years.
CRA is not going to let you off the hook on this one. You must pay any income taxes owing (current or arrears) if you claim bankruptcy.
Debts Due to Fraud
Any debt that was accumulated through fraudulent means is excluded from bankruptcy. A typical example here would be someone who decides to rack up a huge credit card bill making purchases on luxury items within a few months of filing for bankruptcy. This would be considered fraudulent activity.
Paying Off Debts Not Discharged in Bankruptcy
If you have debts that cannot be part of a bankruptcy, there may be ways to alleviate the financial obligation to improve your cash flow. For example, if you are continuing to pay off a mortgage, you may have an option to renew at a lower interest rate or increase your amortization to lower your monthly payments.
If you have a considerable car loan and cannot afford your payments, you may need to sell and downgrade to a more affordable vehicle. It can be a tough choice, but cars are so sturdy these days that even older, higher-mileage models can provide worry-free transportation for several years.
Items like child support, alimony, or income tax arrears can be more challenging to deal with. For income taxes, contact the CRA to see what arrangements they may be willing to make to help you catch up. And while I’m no family law expert, you may be able to renegotiate the terms of your child support or alimony. If two parties agree, anything is possible, and it never hurts to ask.
Things to Consider – Surrendering of Secured Assets
When you claim bankruptcy, you must surrender your assets, such as your home or your vehicle. This might not make sense if you’ve built up a fair amount of equity. For example, if you have $200,000 of net worth in your home, it doesn’t make sense to give it up. Instead of filing for bankruptcy, you’re likely better off with a consumer proposal, which allows you to hold on to your assets.
An exception to this would be if you did not have sufficient equity in your home or your car. There is an allowable amount of equity by which you can maintain these assets, but it varies slightly in each province. For example, if you are the sole owner of a home in Manitoba, you are only permitted to hold onto $2500 of equity in the property. If you own a car in Alberta, the maximum value, or equity, is $5000.
What Can I Keep in Bankruptcy?
In addition to minimum amounts of home or auto equity, the following is a list of assets that are generally exempt from bankruptcy. After all, the process does not intend to take away a person’s dignity. Instead, it’s to help them recover from extreme financial hardship. Keep in mind, the rules surrounding these items can vary from province to province.
- Food & Clothing
- Heating fuel
- Health aids
- Household furniture.
- Business equipment i.e., tools
- Farm equipment, land, animals
When is Bankruptcy the Best Option?
If you own little to no assets and the vast majority of your debt is eligible to be covered with bankruptcy, it might be the best debt recovery option for you. However, it should always be considered a last resort due to the adverse impact it will have on your credit.
Bankruptcy holds one distinct benefit over other debt relief mechanisms, such as debt settlement, or even consumer proposal. That is, when you file, you receive an immediate stay of proceedings, and your unsecured creditors must halt any contact, lawsuits, or wage garnishments they have against you, nor can they start anything new.
This can be a huge relief if you get a lot of harassing phone calls from collection agents. In addition to the legal protection, it covers your unsecured debts and provides a chance to start over. That said, one must keep in mind the limitations of bankruptcy.
As I mentioned above, obligations such as child support, alimony, income tax arrears, and most student loans are not applicable in bankruptcy. That means that they won’t go away. Not only that, if you do have significant assets, but you will also be forced to surrender them to an insolvency trustee. My advice?
Are you still unsure about which debts can be discharged in bankruptcy? Check the financial laws in your province to fully understand how they will apply to your situation.
About the Author
Tom Drake is a Canadian personal finance expert. He is a financial analyst and has been writing about personal finance since 2009 at the award-winning MapleMoney. His work has appeared in Ratehub.ca, MintLife, and Canadian MoneySaver, and he has frequently been quoted in The Globe and Mail, Yahoo Finance, and Financial Post.