Debt Consolidation vs Consumer Proposal: Understanding Your Debt Relief Options

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When struggling to manage multiple debts and faced with a choice between debt consolidation vs consumer proposal, which option is the best way to get out of debt?

In today’s economic landscape, many Canadians find themselves facing overwhelming debt burdens. In fact, according to the latest statistics, about 45 percent of Canadians are just $200 away from failing to meet their financial obligations.

If debts are becoming overwhelming, it becomes crucial to find an effective way to regain financial control. Two common options that Canadian borrowers consider are debt consolidation and consumer proposals. Both offer pathways to debt relief, but they operate differently and suit different financial situations. Understanding the nuances between these options is essential for making informed decisions about managing your finances.

What is Debt Consolidation?

Debt consolidation involves combining multiple debts into a single, larger debt. This is typically achieved by taking out a new loan, often at a lower interest rate than the existing debts, and using it to pay off all outstanding balances. The main goal of debt consolidation is to simplify and lower the monthly payments, and potentially lower the overall interest rate, making it easier for the debtor to pay his or her way out of debt.

Pros of Debt Consolidation:

• Simplified Payments – Instead of managing multiple types of debts, with multiple creditors, due dates, repayment terms and interest rates, debt consolidation combines everything into one loan. You’ll only be making a single monthly payment, which makes it easier to manage the debt and make payments on time.
• Lower Interest Rates – If you qualify for a lower interest rate on the consolidation loan, you could save money on interest payments over time.
• Preservation of Credit Score – As long as you make payments on time, debt consolidation can help preserve your credit score.

Cons of Debt Consolidation:

• Requires Good Credit – Qualifying for a consolidation loan with favorable terms usually requires a decent credit score. According to Equifax, borrowers with a credit score of 740 or higher typically receive the best interest rates. For those with a credit score of under 670, debt consolidation may not be a good option because lenders may potentially give high interest rates to high-risk borrowers.
• Potential for Additional Debt – If you can’t consolidate ALL your debts you could simply be adding to your debt load and possibly worsen your financial situation.

What is a Consumer Proposal?

A Consumer Proposal works similarly to a debt consolidation loan by combining all debts into a single monthly payment that pays all the debts off gradually over time. However, unlike debt consolidation loans, a Consumer Proposal does not involve borrowing or taking on a new loan in order to consolidate debt. You just make an offer to your creditors to settle the whole amount you owe. They can accept it or negotiate the amount with you, but if you reach an agreement with them (as the vast majority of people do) it will get you out of debt.

The offer you make must be something you can actually do, otherwise the proposal settlement will fail. So most proposals are made for a percentage of your total debt. It’s what people can afford.

Consumer Proposals are usually arranged with monthly payments and can significantly decrease the total debt burden, sometimes by as much as 80% or more.

A Consumer Proposal is a formal agreement made between you and your creditors through a licensed insolvency trustee (LIT) and is ratified by the court, which ensures that it is legally binding.

Pros of Consumer Proposals:

• Legal Protection – A crucial aspect of a consumer proposal is the automatic stay of proceedings. This forces your creditors to respond to your consumer proposal. If they ignore it the proposal will be deemed accepted and ratified by the court.
• Stress Relief – The simple filing of the consumer proposal usually stops all collection calls and will stop any legal proceedings immediately.
• Fixed Amount – A consumer proposal is usually approved for a fixed sum. So you know exactly how much you have to pay to get out of debt.
• All Debts Included – Once a consumer proposal is accepted by the creditors and approved by the court, all your unsecured creditors are legally bound to the terms of the proposal.
• No Interest Charges – In a consumer proposal there are no interest charges. The costs of the proposal, such as the trustee’s fees, are paid from the amount you offer.
• Preservation of Assets – By proposing a structured repayment plan through a consumer proposal, you aim to satisfy creditors without resorting to selling off exempt assets such as an RRSP. This protects your essential possessions and allows you to maintain stability in your quality of life.

Cons of Consumer Proposals:

• Credit Impact – People often ask which is worse for my credit score: a consumer proposal or a bankruptcy. The answer is they both have a negative impact, but the proposal is usually somewhat less than a bankruptcy.
• Creditor Acceptance – For the consumer proposal to be accepted, creditors must agree to the proposal. Creditors representing at least 50% of your total debt must vote in favor of the proposal. Once accepted, the proposal becomes legally binding on all creditors, including those who voted against it. If they reject it, you may need to consider alternative debt relief options.
• Some Negotiation may be needed – You start a consumer proposal by make a settlement offer to all your unsecured creditors – usually basing your offer not on how much you owe, but how much can you afford to pay every month. Your creditors are not obligated to accept your offer, but because of the Stay of Proceedings and the alternative of a bankruptcy they do have some incentive to try to arrive at a mutually agreeable settlement. It may involve some negotiations (carried out by the trustee) but 96% of consumer proposals are eventually accepted.

Choosing Between Debt Consolidation and Consumer Proposals

The decision between debt consolidation and a consumer proposal depends on various factors, including your total debt amount, income level, credit score, and overall financial goals. The only way you can get all the information you may need to decide which is better for you is to obtain a proper assessment by a Licensed Insolvency Trustee.

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