The dark cloud of bankruptcy looms over many Canadians who are watching their debts rise faster than their income, but for those not yet drowning, there’s a gentler alternative known as the consumer proposal.
It's a relatively new process that offers creditor protection while a portion of debt is repaid. And as a solution to financial woes, it is quickly becoming more popular than its more painful cousin, the personal bankruptcy filing.
"[Proposals]work out well for the creditors because they're getting some money back, more money back than in a bankruptcy, and from the individual standpoint, it's not a bankruptcy," says Andy Fisher, a bankruptcy trustee at A. Farber & Partners.
Consumer proposals were introduced in the 1990s for people who can’t afford to pay off their debts in full, but have income that is consistent enough that they can continue to make monthly payments. In the aftermath of the global financial crisis, they’re being used more and more.
Last September, the federal government enacted legislation that made filing for bankruptcy more expensive and time consuming and consumer proposals more attractive.
Personal bankruptcies have fallen from peak levels reached during the recession last year - by 7.6 per cent for the first seven months of 2010. The number of consumer proposals increased 30.6 per cent through to July, according to the most recent statistics released this week by the Office of the Superintendent of Bankruptcies.
That bankruptcies are down is a good thing, Mr. Fisher says, but he cautions that it's too early to be too optimistic.
"Even though it appears we're out of a recession, people are still challenged in terms of the amount of debt they carry," he says.
"Relative to other G8 countries, Canadians are carrying the highest level of debt."
Canadians have a serious debt hangover at 145 per cent of disposable income - a ratio over 40 is considered worrisome - and about six in 10 are living paycheque to paycheque, according to two recent studies.
Tom Reid of Transunion credit bureau warns that many Canadians are unaware of the extent of their debt burdens because they don't check their credit reports, make only minimum monthly payments or use one credit card to pay off another.
"You'd be surprised how many people don't know how much they owe to various creditors," he says.
Consumer credit scores trended down last month, he says, a red flag that many Canadians are overspending and need to change their habits before they get into more trouble.
Under a consumer proposal, individuals don't lose their assets as they would under a bankruptcy, as long as they remain committed to paying back their debts. To qualify, applicants must have unsecured debts - credit cards, some lines of credit and unpaid income taxes - greater than $5,000 and less than $250,000.
Bankruptcies stay on a consumer's file for six years after being discharged. Consumer proposals stay for three years from the date they are satisfied or six years from filing date, whichever is less.
How a consumer proposal works:
- A debtor approaches a trustee who will put together an offer to pay creditors a certain percentage of what is owed over a specific period of time based on how much is affordable each month.
- A majority of creditors must accept the proposal, so it has to contain some benefit for them.
- Once the trustee files a proposal with the Office of the Superintendent of Bankruptcy, the debtor stops making payments directly to creditors and any salary garnishments or lawsuits are also halted. Interest payments are frozen from the date of filing.
- Payments are made through the trustee, who acts a liaison between debtor and creditor and divides up either a lump sum or periodic payments among various creditors. Generally, the debt must be paid in five years.
- The trustee receives 20 per cent of that payment but it comes from what is owed to the creditor rather than adding to what is owed.
- If a debtor misses three monthly payments, the proposal will be deemed annulled. That means any protection from creditors is lost and they will be able to reinstate any lawsuit, salary garnishment and the phone calls.
Of course, the best way to avoid either process is to stay out of financial trouble. Get a copy of your credit report and make sense of all your debt obligations. Figure out your debt to income ratio, which is calculated by adding up payments and debt obligations then divided by monthly income.
If the ratio is above 40, re-examine your budget and call creditors to talk about whether there is an opportunity to consolidate loans or reduce interest rates on certain loans.