Consumer Proposal vs Debt Consolidation

Quick Guide: Which Option Is Right For You?

If you’re struggling with monthly payments, understanding the key differences between debt consolidation vs consumer proposals will help you choose the right solution. Your financial situation – including your credit score, income stability, and total debt load – will guide which option better suits your needs.

• Choose Debt Consolidation if you have good credit (650+) or significant home equity, a stable income, and can afford full debt repayment.
• Choose a Consumer Proposal if you can’t afford to repay your debts and need significant debt reduction or creditor protection.
• Not sure? Try our debt reduction calculator and compare options.

Debt Consolidation vs Consumer Proposal: Key Differences

While both options combine your debts into a single payment, their approaches differ significantly. A consumer proposal reduces your total debt through creditor negotiation, while debt consolidation restructures your debt with a new loan. Here are some additional differences between these two debt relief options:

• Debt Reduction: A consumer proposal typically settles debts for 20-50% of what you owe with no interest, whereas debt consolidation simply restructures your debt with no reduction.

• Interest Rates: Consolidation loans charge interest throughout the term, and the rate can vary based on your credit score. Consumer proposals are interest-free once filed.

• Eligibility Requirements: Debt consolidation typically requires good credit (650+ score), stable income, and a healthy debt-to-income ratio. Consumer proposals have no minimum credit score requirement but are available to those owing less than $250,000 (excluding the mortgage on a principal residence) and can repay at least a portion of their debt.

• Monthly Payments: Consolidation loan payments are fixed but must cover principal and interest. Consumer proposal payments are often significantly lower and more flexible.

• Impact on Credit: Consumer proposals can significantly impact credit, with the proposal remaining on your report for three years after completion. Debt consolidation’s impact is generally less severe, provided payments are made consistently.

• Legal Protection: Consumer proposals provide immediate legal protection and stop all collection actions, whereas creditors not paid off through the consolidation loan can still pursue legal action to collect.

• Asset Protection: Consolidation loans may require collateral, and missing payments can put those secured assets at risk. Consumer proposals allow you to keep your assets while settling debts.

• Qualification Requirements: Consumer proposals don’t rely on your credit score, but debt consolidation may require a good credit score to access favourable terms.

• Program Length: Consumer proposals can last up to 5 years but can be paid off early without penalty. The length of a consolidation loan depends on the method of consolidation. Personal loans typically range from 1-5 years, and credit card balance transfers will depend on how quickly you pay off those cards. Refinancing with a mortgage or Home Equity Line of Credit can extend repayment as much as 15 years or more.

How Each Solution Affects Your Credit Score

A primary concern with many Canadians is how each debt solution will impact their credit score. Both options affect your credit score differently over time:

Credit Impact of a Consumer Proposal:

• Reports as an R7 credit rating on your credit report.
• Remains on your credit report for 3 years after completion or 6 years from filing, whichever comes first.
• Your credit score will drop initially, but recovery can begin soon after filing.
• Individual debts included in the proposal will be updated to show “included in consumer proposal”.
• The time clock to remove collection actions and negative payment history begins once you file, which can be good if you have fallen behind on debt payments.

Credit Impact of Debt Consolidation:

• A hard credit check during the loan application process causes a temporary 10-15-point drop.
• Opening a new credit account may initially lower your score by a few points.
• Closing old credit accounts can affect your credit utilization ratio and credit history length.
• Each timely payment helps build a positive credit history; however, late or missed payments will continue to hurt your credit score.
• Your credit score might improve if consolidation reduces credit utilization on revolving credit.

It is important to consider that a consumer proposal provides a clear end date for credit recovery and offers a fresh start with no debt after completion. While debt consolidation maintains your credit history, success depends on making all payments on time. There is a significant risk of additional credit problems if payments become unmanageable.

Debt Consolidation Pros and Cons

Debt consolidation involves taking out a new loan and using the funds to repay existing debt. A debt consolidation loan allows you to combine multiple debts into a single loan, usually at a lower interest rate. Instead of juggling several payments to different creditors each month, you make one monthly payment to a single lender.

Example: Sarah had $25,000 in credit card debt across three cards with 19.99% interest. Through consolidation, she might combine them into one loan at 7%, reducing her monthly payment from $750 to $500.

Pros of Debt Consolidation:

• Lower interest rates can lead to quicker repayment.
• You have the simplicity of managing one monthly payment.
• There is minimal impact on your credit score if payments are made on time.
• You can pick and choose which debts to consolidate.

Cons of Debt Consolidation:

• You will still have to repay all your debts with interest.
• A good credit score is needed to secure favourable loan terms.
• Interest rates may still be high if your creditworthiness is low.
• Your monthly payment may not be affordable.
• Collateral or a co-signer may be required, putting your assets at risk.
• You might be denied a consolidation loan due to poor credit.
• There is a risk of accumulating more debt if you don’t improve your spending habits.

Borrowing against the equity in your home is an extremely risky way to consolidate credit card debt and other outstanding bills. If you fail to make your payments, your lender can take action to foreclose on your home or take back what you have pledged as security for the loan. Second mortgages and unsecured consolidation loans can also carry a very high interest rate.

How Debt Consolidation Works

Refinancing your debts through a debt consolidation loan means taking out a new loan and using the proceeds to pay off existing debt. You can typically consolidate credit card balances, personal loans, lines of credit, and other unsecured debts. However, secured debts like mortgages or car loans can usually not be included.

1. Combine Multiple Debts: Merge various high-interest debts into one loan
2. Lower Your Interest Rate: Typically 7-30%, depending on your credit rating
3. Make One Monthly Payment: Instead of juggling multiple payments

Do You Qualify for Debt Consolidation?

To qualify for a debt consolidation loan, lenders typically look for:

• A credit score of 650 or higher
• Stable income
• Debt-to-income ratio below 40%
• Sufficient equity or assets if securing the loan
• No recent late payments

Interest rates vary significantly based on your credit score and whether the loan is secured or unsecured. You might receive rates anywhere from 7% to 30%, though secured loans typically offer lower rates.

Consumer Proposal Pros and Cons

With a consumer proposal, you work with a Licensed Insolvency Trustee who helps you pay off less than what you owe. This is a legal way to reduce your debt that protects you from creditors while you get back on your feet.

Example: John owed $45,000 in unsecured debt. Through a consumer proposal, he negotiated to pay $21,000 over 5 years with no interest – saving $18,000 plus interest charges and lowering his monthly payments from $1,150 to $350

Pros of Consumer Proposals:

• You can settle debts by up to 80%
• You get lower, more affordable monthly payments
• Proposals are interest free
• It stops collection calls and wage garnishments
• You keep your assets
• You avoid bankruptcy, which has a more severe impact on credit

Cons of Consumer Proposals:

• There will be a negative impact on your credit rating, although the impact is less than bankruptcy.
• Only available to individuals with debt below $250,000 (excluding mortgages)
• While rare, your proposal can be rejected if you can’t negotiate a fair offer with your creditors.
• You must attend two mandatory credit counselling sessions, although these are there to help you with the recovery process.

How Does a Consumer Proposal Work?

When you file a consumer proposal, your LIT will work with you to determine how much you can reasonably afford to pay. They help you make an offer to your creditors that typically involves paying a percentage of your total debt over a period of up to five years, with no interest charges.

The process includes:

1. Financial Assessment: Meet with a Licensed Insolvency Trustee to review your debts, income, and expenses
2. Proposal Development: Create an offer creditors will likely accept, typically 20-50% of total debt
3. Official Filing: Your LIT will submit your proposal to the federal government and the court, as well as send a copy to your creditors
4. Creditor Review: Creditors have 45 days to vote on accepting or rejecting your proposal. Make a counteroffer if necessary.
5. Make Payments: You make fixed monthly payments once accepted, with no interest charges or extra fees.

A consumer proposal can include most unsecured debts, including credit cards, personal loans, lines of credit, payday loans, and even tax debts owed to the Canada Revenue Agency (CRA).

How much debt can you reduce through a consumer proposal? Most consumer proposals reduce unsecured debt by 20-50%. For example, someone with $45,000 in debt might pay $22,500 through monthly payments over 3-5 years, with no additional interest charges.

When Should You Choose Debt Consolidation?

Debt consolidation might be your best option if:

• You can pay your bills, but the interest rates are killing you
• You have a steady income and a good credit score
• Your debt-to-income ratio isn’t too high
• You want to keep your existing credit cards

Watch out, though – if you’re already missing payments or your credit score is low, consolidation probably won’t help. It’s also risky if you keep using credit cards while trying to pay off the consolidation loan.

When Is a Consumer Proposal the Better Choice?

Consider a consumer proposal if:

• You’re drowning in debt payments even after cutting expenses
• Collection agencies are calling, and you need protection from creditor actions
• Your credit score is too low to get a consolidation loan
• You need your payments to be much lower to afford basic living costs

A consumer proposal works particularly well if your unsecured debts exceed $10,000 and you have a steady job but can’t handle the full debt payments anymore.

Making Your Decision Step-by-Step

Making the right choice between debt consolidation and a consumer proposal requires careful consideration. To decide between the two solutions:

1. Calculate your total debt
2. Check your credit score
3. Assess your monthly budget
4. Consider future credit needs
5. Evaluate asset protection needs

If you need help choosing, our Licensed Insolvency Trustees can review your circumstances and help you understand all available options. Book a free, confidential consultation to get started.

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