Handling high amounts of debt is never a fun thing, especially when one has to work hard to pay many loans, credit cards or even overdue bills. If you find yourself at a point where you cannot pay your debts anymore, then it is about time to seek a solution. Out of all the debt relief options available in Canada, debt consolidation and consumer proposals are among the most preferred. Both of these can be a way to alleviate yourself from high debt. However, each of the two options has its pros and cons. So, how do you choose between them?
In this article we will explore what debt consolidation and consumer proposals involve, the pros and cons of each and how you can decide which is the right option for you.
Understanding Debt Consolidation
Debt consolidation is a financial strategy that involves combining all the debts of an individual into a single loan. This enables you to consolidate your debts into one monthly payment at a lower interest rate than what you used to pay. The aim is to make your debt more manageable and to cut down on the amount of money you spend on interest payments.
Key Benefits of Debt Consolidation
Simplified Payments: The first advantage of debt consolidation is simplicity. Instead of having different creditors being paid at different times and varying amounts, the consumer only has to pay one monthly amount. This can assist in reducing the stress of having to remember different due dates and different payment amounts.
Lower Interest Rates: If you get a debt consolidation loan at a lower interest rate, you will be able to save money. Since you are paying less interest, the remaining balance goes to paying down the principal balance that you owe.
Improved Credit Score: Debt consolidation can also be useful in the sense that it will help you improve your credit score. Eliminating high-interest credit cards can help lower your credit utilization ratio, which is a key factor in calculating your credit score.
Downsides of Debt Consolidation
Debt consolidation is useful to pay off debt, but there are some disadvantages. Here are a few potential downsides:
Credit Requirements: Applying for a debt consolidation loan is quite simple; however, some conditions should be fulfilled, including a good credit record and regular income. In particular, if you have a low credit score, it is almost impossible to do something to lower the interest rate for your payments.
No Debt Reduction: Debt consolidation does not forgive any debt but simply rolls all your debts into one. You still have to make full payment of the loan.
What is a Consumer Proposal?
A consumer proposal is an agreement that is legally binding between you and your creditors to pay back your debts in an amount less than what you borrowed. In Canada, a consumer proposal must be done through a Licensed Insolvency Trustee (LIT). The trustee helps you to prepare a proposal to be presented to your creditors.
Key Benefits of a Consumer Proposal
Debt Reduction: Another advantage of a consumer proposal is that the proposal allows you to pay less of your debt. If the creditors accept the proposal, then you may be allowed to pay a percentage of the original amount you owe.
Legal Protection: A consumer proposal provides the debtor with a legal shield as soon as he files the proposal with the officer. This implies that your creditors cannot sue you, garnish your wages or claim your assets.
Retaining Assets: Unlike in bankruptcy, you do not give up your property when making a consumer proposal. This makes it ideal for individuals who do not want to give up their home, car or any other valuable property.
No Interest Accumulation: With a consumer proposal, interest on your debts stops accumulating.
Improved Credit Score Over Time: As you continue to make payments, your credit score will improve over time once the proposal is completed.
Downsides of a Consumer Proposal
Like debt consolidation, a consumer proposal comes with potential drawbacks:
Impact on Credit Score: Filing a consumer proposal will negatively affect your credit score. It is considered an R7 rating, which means that you have agreed to pay back part of your debts. This can complicate the future borrowing process, though it is less severe than bankruptcy.
Longer Process: A consumer proposal takes longer to complete than debt consolidation. The majority of proposals are for five years, so you will have to agree to a long-term repayment schedule.
Not for All Debts: Certain debts, such as student loans (if less than seven years old), child support, and alimony, cannot be included in a consumer proposal. This limits its effectiveness for individuals with these types of obligations.
Need for Professional Assistance: You can only file for a consumer proposal through a Licensed Insolvency Trustee and this comes with some associated costs. However, these fees are normally incorporated into the repayment schedule.
Final Thoughts: Which Option is Best for You?
Debt consolidation or a consumer proposal – the better choice depends on your circumstances and the type of debt relief you need. If your goal is to lower interest and spread payments in a way that will not affect your credit score, then debt consolidation is the right option. However, if you are unable to make minimum payments and need more extensive debt relief, a consumer proposal helps in paying the debt.
The kind of debt you also have also plays a role. Debt consolidation works best for credit card and personal loans, while a consumer proposal works for almost all types of debts, with the exception of student loans and child support.
Finally, if you are being threatened with collection measures such as garnishment of wages, a consumer proposal offers immediate legal shield that is not provided by debt consolidation.
Saqib has a Masters Degree from Wilfrid Laurier University in Ottawa. He has a robust background in accounting and finance. Mohammed started his career three years ago working as an investment analyst at a sell-side firm. He has extensively covered publicly-listed companies using fundamental analysis as the cornerstone of his approach. Mohammed has been published on SeekingAlpha, InvesorPlace, Yahoo! Finance and others.
