Debt Relief Experts
Many Canadians search for relief options when faced with overwhelming debt. Two common choices that come up are debt settlement and consumer proposals. Understanding the differences between these two options is crucial for making an informed decision to deal with your debt problem. It’s not just about choosing the right solution; it’s also about selecting the right company or professional to guide you through the process.
In this comprehensive guide, I’ll explore the key differences between debt settlement and consumer proposals, delve into the potential risks and benefits of working with a debt consultant over a Licensed Insolvency Trustee, and provide insight into the debt settlement process in Canada.
Table of Contents
What is Debt Settlement?
Debt settlement in Canada involves negotiating with creditors to pay less than the full amount owed on unsecured debts. A debtor or a debt settlement company acting on their behalf proposes a lump sum payment to creditors. If the creditor accepts, you pay the agreed amount, and the rest of the debt is forgiven.
Informal debt settlement works with a limited range of unsecured debts, such as credit card debt, some personal loans and lines of credit.
Not all debts can be settled informally. Secured debts (like mortgages or car loans) and government debts (like taxes or student loans) can’t be included when working with an unlicensed debt settlement company.
It’s also important to note that debt settlement is not guaranteed, as creditors are not obligated to accept reduced payments.
What is a Consumer Proposal?
A consumer proposal is a formal, legally binding debt relief option in Canada, regulated by the Bankruptcy and Insolvency Act. Unlike debt settlement, which is informal and handled privately, a consumer proposal is administered by a Licensed Insolvency Trustee.
In a consumer proposal, the debtor offers to pay creditors a percentage of what is owed over a period of up to five years. If accepted by the majority of creditors, the deal becomes binding on all unsecured creditors. You make monthly payments to the LIT, who distributes the funds to your creditors. Once you’ve fulfilled the terms of the proposal, the remaining unsecured debt is legally discharged.
While both consumer proposals and debt settlements aim to reduce debt, consumer proposals offer more legal protection, stop interest charges, and halt collection actions. They also have a less severe impact on credit scores compared to bankruptcies.
Consumer proposals can include most forms of debt, including:
- Credit card debt
- Personal loans
- Lines of credit
- Tax debt
- Student loans (if you’ve been out of school for more than 7 years)
- Payday loans
Secured debts are not included in a consumer proposal.
Key Differences Between Debt Settlement and a Consumer Proposal
Understanding the key differences between these two debt solutions is crucial when deciding how best to eliminate your debt. Let’s break down the main distinctions:
Legal Status
A debt settlement is an informal process with no legal protection. Creditors are not obligated to negotiate or accept your offers.
In contrast, a consumer proposal is a legal process governed by federal law. Once accepted, it’s binding on all unsecured creditors, even those who voted against it.
Who Administers the Process
Debt settlement can be done by yourself or through a for-profit debt settlement company. The government does not regulate these companies, and there are no guidelines for training your debt coach.
A consumer proposal must be administered by a Licensed Insolvency Trustee (LIT), a professional regulated by the federal government. LITs are the only professionals legally allowed to file consumer proposals.
Neither program should be confused with a debt management plan (DMP) offered through non-profit credit counselling agencies. A debt management plan is a debt repayment plan. You work with a credit counsellor to pay back all of your debt. While interest charges can often be reduced or eliminated through a debt management plan, a credit counsellor cannot settle your debts for less than you owe.
Impact on Credit Score
Informal debt settlement can severely damage your credit rating. Missed debt payments during the saving period are reported to credit bureaus, and settled debts are typically noted as “settled for less than full balance,” which negatively impacts your credit. If you stop making payments, your account may be sent to collection, which will also be noted on your credit report.
A consumer proposal also affects your credit score but in a more structured way. It’s noted on your credit report for 3 years after completion or 6 years from the filing date, whichever comes first. However, you can start rebuilding credit immediately after filing.
Amount of Debt
Settling small debt with a creditor or debt collection agency can work. However, a legal settlement option like a consumer proposal is safer if your total debts are large. Generally, debts between $10,000 and the maximum debt limit of $250,000 (excluding a mortgage) are suitable for a consumer proposal.
Approach to Repayment
Debt settlement typically involves saving up for a lump sum payment. You stop making regular payments to creditors while saving, which can lead to increased collection calls and potential legal action. Alternatively, the debt settlement company may work with you for months, collecting a significant unnecessary fee to collect information, only to refer you to a Licensed Insolvency Trustee once you’ve made your necessary payments to the debt settlement company.
A consumer proposal is a structured payment plan, usually with monthly payments over a period of up to 5 years. This structured approach can make budgeting easier and provides immediate relief from collection calls.
Protection from Creditors
There is no legal protection in a debt settlement. Entering into a debt settlement program does not guarantee that you will not receive collection calls, letters, lawsuits or garnishments. Creditors can continue collection efforts, including legal action, while you are working with the debt settlement consultant.
A consumer proposal provides immediate legal protection called a stay of proceeding. Once filed, all unsecured creditors must cease collection actions, including lawsuits and wage garnishments.
Fees and Costs Involved
The big risk with a debt settlement agency is that fees vary widely and are payable whether or not a settlement offer is made. These fees can be substantial, sometimes 20-25% of the enrolled debt.
Consumer proposal fees are regulated by law and are included in your proposal payments. There are no upfront costs, and the fees don’t increase the amount you pay under the terms of your proposal agreement. You do not start making payments to your LIT until your proposal offer is filed with the government.
Lender Acceptance
In a debt settlement, each lender must be negotiated with separately, and there’s no guarantee that all creditors will accept the settlement offers.
Once a consumer proposal is accepted by the majority of creditors, it becomes binding on all unsecured creditors, ensuring a comprehensive debt solution. At Hoyes Michalos, we have a 99% acceptance rate for consumer proposals.
The Risks of Using a Debt Settlement Company
While debt settlement might seem attractive, especially with promises of settling your debt for “pennies on the dollar,” it comes with significant risks:
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No Guaranteed Results: Creditors are not obligated to negotiate or accept settlement offers. You might spend months trying to settle, only to end up worse off than when you started.
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Increased Collection Calls: While you’re saving for a settlement, creditors may increase their collection efforts, leading to more frequent and aggressive collection calls.
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Potential for Lawsuits: Because there is no formal arrangement, creditors can sue you for the amounts owed. This can result in wage garnishments or liens on your property.
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Significant Credit Score Damage: Your credit score can plummet due to missed payments and accounts sent to collection.
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High Fees: Some debt settlement companies charge high fees, which can offset any savings from debt reduction. There is no evidence that debt settlement companies can negotiate a better deal than a Licensed Insolvency Trustee, especially after adding their extra fees.
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Scams and Fraud: The debt settlement industry is largely unregulated, making it ripe for scams and fraudulent practices.
Canadian Government’s Consumer Alert for Debt Settlement
The Financial Consumer Agency of Canada (FCAC) has issued warnings about unregulated debt advisors. These warnings highlight that many debt consultants are not licensed or regulated and charge high upfront fees without delivering promised services. Because they are not licensed, debt consultants can’t provide the legal protections offered by licensed professionals like LITs. Working with an unregulated debt advisor can worsen your financial situation. The FCAC strongly recommends consulting with a Licensed Insolvency Trustee before making any decisions about debt relief.
The Office of the Superintendent of Bankruptcy also issued a report concerning the practice of LITs taking referrals from fee-charging third parties or debt consultants. Often found online, these companies advertise debt settlements or government debt relief programs but cannot legally offer a consumer proposal. Their process is to charge significant fees, averaging $2,400 and as high as $4,200, for collecting information from the debtor and preparing the paperwork to file a consumer proposal. Only after collecting thousands of dollars do they refer the client to the trustee. Reputable trustees do this form of debt assessment for free. It is important to understand who you are dealing with. There are roughly 1,000 active Licensed Insolvency Trustees in Canada. As noted in the report, only 13 LIT firms had a “frequent and sustained relationship” with two large-volume debt consulting agencies.
To be clear, Hoyes, Michalos & Associates Inc. does not have a referral arrangement with any debt consultant agency. When you contact our office for debt help, you will speak with a Licensed Insolvency Trustee and have access to that trustee throughout your consumer proposal, not just at signup.
Why Use a Consumer Proposal for Debt Settlement
Given the risks associated with informal debt settlement, a consumer proposal provides a safer, more structured alternative. Here are some key advantages:
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Legal Protection: Upon filing a consumer proposal, there is an immediate stay of proceedings, which means that lawsuits and garnishments from credit card companies and banks are required to stop while the proposal is considered.
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Certainty: Once accepted, the terms are binding on all creditors. With a consumer proposal, creditors agree to the negotiated terms at the start of the process, and then your Licensed Insolvency Trustee makes regularly scheduled distributions to the creditors.
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Debt Reduction: You repay only a portion of your debts, which results in a significant debt reduction, sometimes up to 70-80%.
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Fixed Payments: Monthly payments are fixed, making budgeting easier.
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Interest Freeze: Interest stops accumulating from the date of filing.
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Retain Assets: Unlike bankruptcy, you typically keep your assets in a consumer proposal.
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Professional Guidance: Administered by Licensed Insolvency Trustees, ensuring expert advice and adherence to regulations.
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Transparent Fees: Costs are regulated and included in your payments.
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Credit Rebuilding: You can start rebuilding credit immediately after filing.
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Comprehensive Debt Solution: A consumer proposal addresses all unsecured debts at once, providing a holistic approach to debt management.
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Low Structured Payments: A consumer proposal allows for manageable monthly payments, which are often less than the minimum payments on high-interest credit cards, payday loans, and installment debt.
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Counselling Sessions: Consumer proposals include two mandatory credit counselling sessions, which provide valuable financial education to help prevent future debt problems.
The Role of Professional Advice
Professional advice from a Licensed Insolvency Trustee (LIT) is invaluable when looking for debt relief options.
Licensed Insolvency Trustees (LITs) are federal government-licensed professionals who offer valuable debt relief advice. They:
- Administer consumer proposals and personal bankruptcy
- Provide comprehensive financial assessments and legal expertise
- Adhere to strict ethical standards
- Understand insolvency law and creditor expectations
- Offer free initial consultations
- Have regulated fees included in creditor proposals
Remember, there’s no one-size-fits-all solution. While the main difference between a debt settlement and consumer proposal come down to cost and success rate, the best choice depends on your unique circumstances. Debt settlement programs don’t work in most cases. Many creditors, including the Canada Revenue Agency (CRA), will not negotiate with debt settlement companies.
If you need help with debt, contact Hoyes Michalos for a free consultation. As a Licensed Insolvency Trustee, we can help you make the right decision by assessing your eligibility for a consumer proposal, analyzing your financial situation to determine the best offer for creditors, and explaining various debt relief options, including debt consolidation, credit counselling and a consumer proposal. We will guide you through the legal process if you choose to file a proposal or bankruptcy, provide budgeting advice, and aim to give you a fresh financial start. Our goal is to help you find the best solution to become debt-free while ensuring you understand the long-term implications of each option on your credit and financial future.
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Frequently Asked Questions
Is debt settlement the same as a consumer proposal?
No, they are different processes. Debt settlement is an informal negotiation with creditors, often done through unregulated companies. A consumer proposal is a legal process administered by a Licensed Insolvency Trustee and provides legal protection from creditors.
Is debt settlement better than collections?
An account in collection will remain on your credit report for seven years. Making an offer to a collection agency through an informal debt settlement can lengthen the time your debt remains on your credit report. However, a debt collector cannot legally sue past the statute of limitation period. Talk with a Licensed Insolvency Trustee about the pros and cons of filing a consumer proposal versus ignoring an account in collection.
Can I negotiate with creditors on my own?
Yes, you can negotiate with creditors directly. This can be a good option if you have a lump sum available and feel comfortable negotiating. However, creditors are not obligated to negotiate, and you won’t have the legal protections a consumer proposal offers.
What is the downside of a consumer proposal?
While consumer proposals offer many benefits, there are some downsides to consider:
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A note that you filed a consumer proposal will appear on your credit report, affecting your credit score initially.
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You may have to make higher monthly payments if you own significant assets, including home equity.
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The proposal might be rejected, although this is rare if the offer is reasonable.
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You will have to give up your credit cards, although most people can obtain a new one soon after filing. This credit card, with a new payment history, can help you rebuild your credit.
Can a consumer proposal help stop collection calls?
Yes, a significant benefit of a consumer proposal is that it provides immediate legal protection from creditors. Once you file a consumer proposal, all collection actions, including calls, must cease.
Is debt settlement good or bad?
Settling debts for less than you owe is a viable solution to dealing with problem debt. Paying your debts in full is always better for your credit report. However, if you can’t afford to pay off your debt, working with a Licensed Insolvency Trustee to settle your debts legally through a consumer proposal is a good option.
