Series by Victor Fong
Introduction: Finding Debt Relief and Rehabilitation
Bankruptcy is a scary word. It conjures up images of losing your home, destroying your credit, and other unpleasant thoughts. But it can provide relief from a crushing debt burden, so for some people it can be the right move.
Do you remember going to see the doctor when you were a child? You dreaded getting jabbed with a needle for a blood sample or having to take some awful-tasting medicine, but before you knew it, it was done and over with and the sting went away. One can think of the personal bankruptcy process in the same way – you dread filing for bankruptcy and expect it to be painful, but before you know it your debts are gone and you’ve moved on with your life.
You should be aware that the bankruptcy system exists to work for you as well as your creditors. The personal bankruptcy process has the objective of rehabilitating the debtor, so that they can become a productive member of society without the burden of crushing debt. The bankruptcy system also ensures that all creditors are treated fairly and get an appropriate share of any assets from the debtor.
If you find yourself struggling to stay on top of your debts, you may be able to solve the problem without needing a break from your creditors. For example, a money coach might help you budget better, or a counsellor may help you with underlying issues such as problem gambling. But when your debt situation is overwhelming, it may be time to speak to a licensed insolvency trustee to evaluate your financial situation and determine if it’s time to ask your creditors for relief.
There are several ways to seek relief from your debts, and we will discuss each in more detail in subsequent articles. These options are governed by the Bankruptcy and Insolvency Act.
A consumer proposal is a formal repayment plan that can be tailored to your ability to pay, and minimizes the impact on your credit rating. Creditors may also receive more money than in a bankruptcy. Consumer proposals are for debts that do not exceed $250,000 (excluding mortgage debt on your home).
Personal bankruptcy is where you legally assign your assets to a trustee who will liquidate them and remit the proceeds to your creditors. You can retain some personal assets, such as necessary clothing, and specified amounts of household furnishings, tools, etc. Bankruptcy will stop wage garnishments and legal proceedings, but will have the most severe impact on your credit rating.
A Division 1 Proposal is like a consumer proposal, a legal process available under the Bankruptcy and Insolvency Act that allows you to settle with your creditors and avoid bankruptcy, used when your liabilities exceed $250,000.
Settling tax debt can lead to particular considerations and ways of dealing with the Canada Revenue Agency worthy of its own article, though the proposals use the same framework as a consumer proposal or division 1 proposal.
Starting Over – Rebuilding your Credit
One concern for many individuals contemplating a consumer proposal or bankruptcy is the effect on their credit rating. Your credit rating for a particular loan account will range from R1 – a revolving account in good standing, to R9 – a revolving account in very poor standing.
Bankruptcy will bring a person’s credit rating for each loan account included in her bankruptcy proceedings to an R9 with the credit bureau. It will remain so for 6 years after a discharge from bankruptcy, after which it will be deleted from the debtor’s credit file. For a consumer proposal, A debtor’s credit rating will be downgraded to an “R9” rating with the credit bureau during the performance of the consumer proposal. Once the consumer proposal is completed, the credit rating will be upgraded to “R7”, and will so remain for 3 years. After 3 years, the R7 is deleted from the debtor’s credit file.
Moreover, your credit score will be impacted. This is a number out of 900 which represents an overall assessment of your credit worthiness. This is called a FICO score and is calculated based on the following factors:
- Your payment history comprises 35% of your FICO score. It includes which of your accounts were paid on time, the amounts owed and the length of any delinquencies. Also included are any adverse public records such as bankruptcies, judgments or liens.
- Data about your debts comprises 30% of your FICO score. This data includes the number of accounts you owe money on, the type of debt and its total amount. Also included is your credit utilization rate.
- The length of your credit history comprises 15% of your FICO score. This factor includes the length of time your accounts have been open and how long it’s been since they’ve been active.
- The types of credit used comprise another 10% of your FICO score. Having a greater variety of differing types of accounts such as credit cards, mortgage payments and retail accounts is more beneficial than holding fewer.
- The last 10% of your FICO score is made up of data related to new credit applications such as the number of recent credit inquiries, and how many new accounts have been opened. Opening up too many accounts in too short of a time period is interpreted as a sign of risk and will lower your score.
Does this necessarily mean that you won’t be able to get credit during this period? No, it does not.
Your credit history and credit score are certainly important factors in determining your credit worthiness. However, lenders will look at other factors such as your income and your ability to get a guarantor or co-borrower. There are also other devices through which you can rebuild your credit:
- Secured credit cards – Certain financial institutions issue secured credit cards. By providing a bank or trust company with cash as security against any purchases, such as by providing a money order along with the credit card application, you’ll be issued a credit card with a maximum credit limit equal to the money provided. For example, you submit a $1,000 money order along with the application form, and you are issued a credit card with a limit of $1,000. The bank has your $1,000 as security to ensure you pay your credit card balance.
- Mortgage brokers – If you are in the market for a home and need financing, a mortgage broker will shop around for the best mortgage rate available to you given your bankruptcy. However, due to your bankruptcy, the rate offered to you will usually be above current market rates. In many cases these higher rates may make renting a better financial choice, though the rent-vs-buy consideration is dependent on many factors, and a credit check may also be part of a landlord’s screening process.
If your debts are overwhelming and you don’t see a way to get out from under them, an insolvency trustee may be able to help you understand your options.
Insolvency trustees are also in a position to help you rebuild your credit, and can refer you to organizations that can assist in financing a vehicle, making a real estate purchase, or securing a credit card account notwithstanding your bankruptcy.