Take these two steps before you decide it’s time to file.
Deciding to file bankruptcy is a serious decision that shouldn’t be taken lightly. It’s important to weigh the pros and cons of bankruptcy and understand how they apply in your financial situation. You also need to explore all the alternatives to bankruptcy to make sure it’s the best solution for your needs.
This guide walks you through these two important considerations, so you can make an informed decision as you move forward.
Step 1: Weigh the pros and cons of bankruptcy
Understandably, you may be concerned about the downsides of filing bankruptcy. However, the potential negatives are outweighed by the benefits in many situations. This table overviews the basic pros and cons that you need to consider:
- You can get a fresh start with your finances
- Most (not all) of your obligations will be forgiven
- Calls from creditors and collectors will stop
- You will be protected from wage garnishment and court actions
- You could be debt-free in as few as 9 months
- Bankruptcy will negatively impact your credit for at least six years
- Any assets that are not exempt will be liquidated to pay your creditors
- Bankruptcy can be more costly than you might think
- It requires a full and continuous financial disclosure
- The filing will become a public record
The benefits of bankruptcy
Being mired in debt can be exhausting. Juggling bills and dealing with calls from creditors and collectors can be a constant source of stress. Getting a fresh start by completing a bankruptcy filing will get that weight off your shoulders. You can move forward without all that debt weighing you down and holding you back from your goals.
And while you will face some credit damage from bankruptcy discharge, it can stop the continuous damage you may be facing now. You can start rebuilding your credit, instead of continuing to face penalties from missed payments, charge-offs, and debt collections.
Any unsecured debts (credit cards, lines of credit, personal loans, payday loans and tax debts) will be cleared during bankruptcy. That means fewer bills to worry about, so it’s easier to balance your budget.
There are some obligations that you won’t be able to clear. Any child or spousal support payments will continue, as well as payments for other court judgments. Student loans may be cleared in some cases, but only if you’ve been out of school for seven years or more.
Creditors and collectors can be aggressive when seeking payment. They make demands and even threats about what will happen if you don’t pay. You may be scared to even answer the phone or check your voicemail. You may also flood your mailbox, your inbox and text messages.
Filing for bankruptcy stops all these interactions because of the Stay of Proceedings. The minute you file, an automatic stay is issued. All collection attempts stop, so even before the final discharge of your balances, you’ll get relief.
Another benefit of the automatic Stay of Proceedings is that it stops other attempts to collect. This includes wage garnishment, including existing garnishments that may be in place. Creditors and collectors also won’t be able to take you to court. Everything will be handled through your Licensed Insolvency Trustee (also known as a bankruptcy trustee).
Most first-time bankruptcy filings are completed after nine months. If the trustee finds that you have surplus income (income above a certain threshold), filing can take up to 21 months.
For anyone that has filed bankruptcy before, the second bankruptcy will take longer. If you fall below the surplus income threshold, it will take 24 months or 36 months if you’re above that threshold.
The drawbacks of bankruptcy
Filing bankruptcy will result in an R9 notation on your credit report, which is the worst notation you can incur. As a result, it can have a significant negative impact on your credit score.
The good news is that this damage doesn’t last forever. A first filing will only stay on your credit report for 6 years, while a second filing will stay for 14.
While this may seem like forever, it at least gives you a definitive date when your credit will be cleared of any damage. What’s more, you can start to rebuild your credit even before the penalty expires.
Any assets that do not qualify for an exemption will be sold and the proceeds will be used to repay your creditors. However, this doesn’t mean that you’ll lose everything. Personal items, such as your clothing, household items, tools for work and even a car up to a certain value will be exempt.
Most savings in a Registered Retirement Savings Plan (RRSP), Registered Education Savings Plan (RESP) or pension will also be protected. However, contributions made in the past 12 months will not be exempt.
Bankruptcy trustees (Licensed Insolvency Trustees) get compensated for overseeing your filing and you pay that compensation. You must pay the trustee a monthly base contribution cost, which averages $200 per month.
Then, if your income puts you above the surplus income threshold, you must also cover surplus income costs.
The Licensed Insolvency Trustee will help you complete a Statement of Affairs. It will detail your income, assets, liabilities (debts), and even certain financial transactions. The court and trustee will essentially know everything about your financial life.
Then, during the bankruptcy process, you must submit tax documents and pay stubs to show your income. This is how the trustee determines if you have surplus income.
This last point is not as scary as it sounds. Your Licensed Insolvency Trustee will report the filing to the Office of the Superintendent of Bankruptcy. The filing becomes part of the permanent public record in Canada. However, for most people, the only people that will know you filed are your trustee and your creditors.
Step 2: Consider your alternatives to bankruptcy
Even now that you understand the pros and cons, you shouldn’t contact a Licensed Insolvency Trustee just yet. Before you do, you need to explore all the bankruptcy alternatives. This includes:
- Debt consolidation
- Credit counselling
- Debt settlement
- Consumer proposals
Bankruptcy should really only be considered once you’ve exhausted any other options. If you can get out of debt without the cost, credit damage and public record of bankruptcy, then it’s in your best interest to do so.
Explore bankruptcy alternatives
The first and best option you should consider is debt consolidation. This involves taking out an unsecured personal loan to pay off your existing debts. This solution will only work if:
- You have a good or excellent credit score to qualify for the loan at a lower interest rate.
- You would be able to pay off all your existing debt with the loan amount you can qualify to receive.
Most lenders only offer loans personal loans up to $50,000 unless you earn a high income ($150,000). If your unsecured debt exceeds that amount, the consolidation may not be as beneficial. You won’t be able to roll all your bills into one monthly payment, which is a primary benefit of consolidation.
In addition, if you have bad credit, you either won’t get approved or the interest rate will be too high. Another big benefit of consolidation is that it lowers the interest rate applied to your debt. That makes it easier to pay off your debt faster because you don’t waste money on accrued monthly interest charges.
But consolidation offers significant advantages over bankruptcy if you qualify and have the right financial situation. It doesn’t damage your credit and could improve it. It also doesn’t create any public record. The cost is generally lower as well because you usually only need to pay a loan origination fee. This is rolled into the loan payments and is typically only a small percentage of what you borrow.
The next option to consider is enrolling in a debt management plan through a credit counselling agency. Nonprofit consumer credit counselling agencies exist to help consumers who have gotten overextended with credit cards and other unsecured debts.
A credit counsellor conducts a basic review of your debts, credit, and budget to help you understand your options for relief. If you can’t consolidate on your own, but can afford to pay back everything you owe, then you may qualify for a debt management plan.
This is a repayment plan that the credit counselling agency helps you arrange with your creditors. The counsellor helps you find a monthly payment that you can afford that will pay off all your debts in 60 payments or less. Then they work with your creditors to eliminate or reduce the interest charges applied to your debt.
You make one payment to the agency and they distribute the payment on your behalf. Since you pay your debt back on an adjusted payment schedule, this will result in some credit damage. A debt management plan is noted on your credit report for two years from the date you complete the program.
However, the credit report notation is an R7 rather than the R9 you get with bankruptcy. Credit counselling also doesn’t become part of the public record. The fees for a debt management plan are relatively low compared to other solutions and rolled into the monthly payment.
If you can’t afford to pay back everything you owe, then it may be time to consider getting out of debt for less than you owe. There are several ways to do this, including bankruptcy, but the first method to consider is debt settlement.
With private debt settlement, you avoid the full financial disclosure that’s required when you contact a Licensed Insolvency Trustee. You work with a private debt settlement company, which is there to negotiate on your behalf, so you can get out of debt for the least amount of money possible.
The settlement company helps you set up a trust account to gather the funds you’ll need to make settlement offers to your creditors. They work with you to set a budget so you can set aside as much money as possible to generate these funds quickly.
Once you have enough money in the trust, they contact your creditors to negotiate. Instead of figuring out how much you can reasonably afford to pay, their goal is to help you discharge for the lowest percentage possible.
Once your creditor agrees to a settlement, they draft a formal agreement that you sign. The funds are withdrawn from the trust to pay the percentage agreed to. Then the settlement company takes their fees out of the trust as well.
Debt settlement will damage your credit score. You incur the same R9 penalty that you get with bankruptcy. However, unlike bankruptcy and consumer proposals, it does not become a public record.
The final option before bankruptcy is to file a consumer proposal. This option also gets you out of debt for less than you owe. However, unlike settlement, it’s arranged through a Licensed Insolvency Trustee.
The trustee determines how much you can reasonably afford to pay, then they set up a payment plan with a term of up to 60 months. Once the trustee arranges the repayment plan, both you and your creditors agree to it in a legally binding contract.
You make the payments to the trustee and they distribute the funds to your creditors as agreed. Once all the payments are made, your creditors discharge the remaining balances.
A consumer proposal is relatively expensive compared to other solutions. There is a $1,500 filing fee just to set it up. Then the trustee takes 20% of all future payments.
A consumer proposal does become a matter of public record like bankruptcy. However, the credit report notation is an R7 instead of R9. The penalty only remains on your report for three years from the date of final discharge. That’s half the time of a first bankruptcy.
Understand your options