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Consumer Proposal vs Bankruptcy – Know Your Options

Consumer proposal vs bankruptcy conversations may leave you more confused about your financial situation. Canadians have a growing willingness to file consumer proposals instead of bankruptcy protection. The Canadian government aimed to give consumers a way out of debt without losing their assets. The consumer proposal has been a popular way for individuals with debt to deal with their debt burden.

The consumer proposal is similar to bankruptcy in several ways, including its effect on your credit. Moreover, since individuals with large debt burdens routinely turn to a consumer proposal or bankruptcy after they find that they are not good candidates for other debt relief options such as consumer credit counselling or debt consolidation, it is good to have an understanding as to why one might choose a consumer proposal over bankruptcy or vice versa.

What is a consumer proposal?

A consumer proposal is a debt settlement arrangement. In Canada, a Licensed Insolvency Trustee (LIT) files them on behalf of applicants. The LIT negotiates with your lenders on your behalf. It is a preferable alternative to bankruptcy in most cases. Applicants often pay significantly less debt, up to 70% or 80%, than they initially owed. Additionally, they are usually able to keep most of their assets.

Upon approval, it is a legally binding document between you and any creditors included in the proposal. You must keep up the regular monthly payments and attend two mandatory credit counselling sessions.

What is bankruptcy?

Bankruptcy is often considered a last resort. Most other debt management solutions are better alternatives if an applicant is eligible for them. To have almost all your debts forgiven file for bankruptcy. However, it often results in having to give up certain assets and a drop in your credit score.

Note that bankruptcy affects a lot of different areas of your life. The cost of filing can be expensive. For example, you pay a monthly base contribution to your trustee. How much it is varies by trustee. Your trustee acquires any unexempt assets, such as your car or your house. The LIT then disperses any funds derived from selling these assets to your creditors. Finally, bankruptcy protection regulations have a cap on how much you can earn. Your trustee disperses any surplus monthly income of $200 greater than the limit on earnings set by the superintendent of bankruptcy.

Key differences between a consumer proposal and bankruptcy

There are a few important distinctions between a consumer proposal vs bankruptcy. They’re outlined here to help you make an informed decision best suited to your specific situation.

Effects on credit score

A consumer proposal results in an R7 rating on your credit report. It stays on your credit report for 3 years after you pay it off in full. For example, if you pay it off in 3 years, the R7 rating will stay for a total of 6 years. 

A bankruptcy, on the other hand, will result in an R9 rating on your credit report, which is the harshest possible rating. It stays on your report for 7 years.

Effects on assets

With bankruptcy, there are several exemptions available for you to keep your assets. For example, RRSPs are exempt in all regions. On the other hand, some exemptions differ based on provincial and territory guidelines. In some areas, assets like home equity, vehicle equity, pets, food and clothing are exempt. In others, they’re not. Rules also vary in terms of the limits set in; various categories, total asset value, and total exempt value. Before moving forward with bankruptcy, it’s best to check what rules apply to your area.

A consumer proposal protects your existing assets, like your home and car, from creditor seizure and wage garnishment. This is much better than bankruptcy. That said, here too, the rules vary by province and territory.

Effects on employment income

Filing a consumer proposal or bankruptcy initiates a “stay of proceedings”. This ensures that most types of wage garnishment will stop when you file. That said, wage garnishment due to overdue child support or alimony, is likely to continue.

It’s when income level changes that the difference between consumer proposals vs bankruptcy shows up. Change in income has no impact on a consumer proposal. Bankruptcy, on the other hand, requires the disbursement of any surplus income above a certain level.

Rebuilding your credit after a consumer proposal or bankruptcy

Both have a strong negative effect on your credit, but a consumer proposal is less harsh. It stays on your credit report for a slightly shorter duration, and the rating is relatively better.

In general, consumer proposals allow you to rebuild your credit a bit quicker compared to bankruptcy. You’re also more likely to qualify for new credit with a consumer proposal, compared to bankruptcy. 

Strategies to rebuild your credit are applicable for both and will improve your credit score to varying degrees. It is important to ensure you’re living within your means. To do that successfully, create a budget and stick to it. Credit rebuilding relies heavily on paying all your bills on time, including phone and utility bills. This helps show your reliability to the lenders. It may also be useful to get a secured credit card, which will help build up a history of creditworthiness for you.

Time needed to complete the process

Bankruptcy is a last resort option that involves a relatively quick process. You may be able to get a discharge in as little as nine months. However, many people do not get the automatic discharge in bankruptcy, which can extend the length of time between bankruptcy filing and discharge by several years.

A consumer proposal can vary in terms of duration – it depends on your specific situation, the proposal you put together, and how much you are able to pay on a monthly basis. However, a consumer proposal cannot go beyond 5 years.

Cost differences between consumer proposal vs bankruptcy

Consumer proposals are tailor-made for each applicant, as everyone’s financial situation and life circumstances are different. Along with standard administration fees, your proposal would usually offer to pay creditors a portion of your total debt or request a time extension. Often, trustees present both these offers to creditors. Acceptance of this proposal depends on your financial situation, existing debt amount, ability to repay, and other additional factors.

For bankruptcy, the cost of filing includes a monthly base contribution cost, as well as associated fees, if any. LITs deposit non-exempt assets in a trust. Any surplus income above a certain limit, you’re required to send it to your trustee so they can forward it to your creditors. Do your research and speak to a licensed trustee for more insight on your specific situation.

Eligible debts

Debt amounts from $1,000 to $250,000 are eligible for a consumer proposal. For jointly filing with a spouse, it increases to $500,000. Secured loans like home loans or car loans are not covered. Your existing assets remain untouched as well. 

Credit cards, personal loans, other unsecured forms of debt, and student loans are generally covered under bankruptcy. There are some timelines that these debts need to fall in to be covered. For example, if you were a student more than 7 years ago, your student loans are eligible to be covered. If your utility bills or medical bills are overdue for payment, they may be eligible for inclusion as well.

Debts that are not included

Consumer proposals do not cover secured debt. If you’re in debt due to a mortgage or vehicle loan, a consumer proposal may not be the right choice for you. If your existing secured loan is not eligible and you want to clear off that debt there are a couple of options. You may be able to sell the asset or allow the creditor to take possession of it. Any shortfall could then be included in the proposal. when the consumer proposal starts.

If you pay child support, alimony, or have recent student loans, these cannot be discharged under bankruptcy. Taxes owed, interest, and penalties (if any) to the Canada Revenue Agency, especially if there is a lien on your property are also not eligible.

Eligibility differences

If you owe between $1,000 to $250,000 of unsecured debt and are unable to keep up with your debt payments, you may be eligible to file a consumer proposal. You must be filing as an individual, not a business or corporation. You will need to show proof of regular income and are able to make the monthly payments on time.

If you owe more than $1,000 and are considered insolvent, you can file for bankruptcy. You must be a Canadian resident. It is a low-cost option for quick debt relief, especially if you don’t have many non-exempt assets that would be seized.

The Bankruptcy and Insolvency Act of 1985 defines an insolvent person as: 
a person who is not bankrupt and who resides, carries on business or has property in Canada, whose liabilities to creditors provable as claims under this Act amount to one thousand dollars, and
(a) who is for any reason unable to meet his obligations as they generally become due,
(b) who has ceased paying his current obligations in the ordinary course of business as they generally become due, or
(c) the aggregate of whose property is not, at a fair valuation, sufficient, or, if disposed of at a fairly conducted sale under legal process, would not be sufficient to enable payment of all his obligations, due and accruing due;

When is a consumer proposal a better option?

A consumer proposal is a better option than bankruptcy in many ways. Your assets and income are protected from being seized or garnished. The “stay of proceedings” means that you will not be charged any interest once you file. It is also relatively easier to rebuild your credit rating after a consumer proposal, as compared to bankruptcy.

Another relative advantage is that the terms of the consumer proposal would not change based on any change in your finances. If your earnings increase, you won’t have to pay more. You will be able to continue making the same payments you were making, as agreed upon in the proposal that was approved. If you had filed for bankruptcy instead, a re-negotiation would happen based on your change in income.

When is bankruptcy a better option?

If you need a quick resolution and are genuinely unable to make the payments, bankruptcy might be a good option. This is especially true if you can be considered insolvent, and don’t own non-exempt assets. If your home or personal property is at risk of being seized as collateral, bankruptcy may be worth consideration. Keep in mind that bankruptcy is usually considered a last resort, so find out if other debt-relief options are more viable for you.

It does have a drastic effect on your credit score for many years, so the process of rebuilding it will take time and commitment. If you have considered all other debt-relief options and you think they won’t work for you, look into bankruptcy. You can reach out for a consultation and talk to a counsellor if you want to learn more about the options available to you.

Consumer proposal vs bankruptcy – How to decide?

Choosing between a consumer proposal vs bankruptcy depends heavily on your personal circumstances. Asking yourself these questions can help you decide which is best for you.

How much is your total debt?

A consumer proposal has maximum debt levels that set a limit on how much you can include under your proposal. Single individuals do not qualify for a consumer proposal if they owe more than $250,000. Those filing jointly do not qualify with over $500,000 of debt.

Can you make any payments on your debt?

A consumer proposal is only a good choice for you if you can afford to make some of your payments on your debt every month. If you are completely unable to make any of your minimum debt payments, bankruptcy is your only option.

When do you want to be debt-free?

Many Canadians choose bankruptcy because they believe it is the quickest way to get out of debt. After all, while not guaranteed, first-time filers for bankruptcy are eligible for an automatic bankruptcy discharge after nine months. Because the consumer proposal sets up a payment plan for a large amount of debt, you are unlikely to be done with the proposal in nine months or less.

Are you willing to give up your assets?

The biggest difference when comparing consumer proposals vs bankruptcy is how your assets, including material possessions and income, are treated

The disadvantage of bankruptcy is that you will be forced to surrender your assets to your trustee for distribution to your creditors. There are some exemptions that allow you to keep the basic necessities and tools that you need for your employment. Still, you will give up many of your personal possessions, including property such as a home. Any surplus earnings are also required to be distributed.

Doing a consumer proposal you’re not required to surrender any assets to your trustee as long as you are current on your payments as outlined in the agreement between you and your creditors. Moreover, the payment amount fixed by the consumer proposal never changes. Even if your income increases during the repayment period, your monthly consumer proposal payments will remain level.

Key takeaways

Consumer proposals and bankruptcy are both viable debt relief solutions. Which option is better for you depends on many factors, including your current financial situation. 

A consumer proposal is often a preferable alternative to filing for bankruptcy. Both are filed through a Licensed Insolvency Trustee (LIT), who negotiates with creditors for you. Both also affect your credit score, but the consumer proposal would be less damaging. It adds an R7 rating to your credit report, which is preferable to the R9 that bankruptcy would add. 

Before moving forward, it is important to understand the key differences between both, as it relates to income, existing assets, and the rules in your area.

Consider the pros and cons between consumer proposal vs bankruptcy fully for your life situations and finances. If you have the income available for a consumer proposal and can afford the monthly payments, it is a preferable option in most cases. 

Contact us today! An expert from our team will discuss your situation and options, so you can decide whether a consumer proposal would help, or if filing for bankruptcy is the only way to get out of debt. You can even ask them for recommendations on other debt-relief options that may be a better choice.

Frequently asked questions 

What happens to my tax refund with a consumer proposal vs bankruptcy?

With a consumer proposal, you typically get to keep your tax refunds unless you have prior tax debt or any outstanding tax filings. If you don’t have any such pending payments, the Canada Revenue Agency (CRA) will send you your tax returns. You still need to file your income taxes as usual.

With bankruptcy, you will not get to keep your tax refunds. Any refunds you would be eligible for are considered the property of the estate. This means that it will be sent to your trustee, and will be available to your creditors.

What’s worse for my credit score – consumer proposal or bankruptcy?

In terms of your credit score, consumer proposals add an R7 rating to your credit report, which stays on your report for 3 years after you fully pay off the proposal. It is harsh on your credit, but relatively better than the effects of bankruptcy.

Bankruptcy, on the other hand, adds an R9 rating, which has the harshest effect. This rating stays on your credit report for 7 years. Overall, bankruptcy is worse than a consumer proposal for your credit score.

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