Roger’s is the story of a young man – in his early 20s at the time – who somehow was able to borrow well beyond his means to buy an expensive vehicle. He didn’t fully understand the terms of the loan, a high-interest line of credit on which he pays interest only.
“The vehicle ended up being a lemon and essentially worthless 2.5 years later,” Roger writes in an e-mail.
Since getting his masters of business administration degree, Roger, now aged 31, has landed a job in finance earning $75,000 a year. He has $50,000 in a locked-in retirement account (LIRA) from a previous employer that he wonders if he can tap.
“That line of credit is a major burden on my finances,” Roger adds. Living in expensive British Columbia, “I am only squeaking by.” He wonders whether he can reach a settlement with the bank, or even declare bankruptcy, “although it will sting for a long time.” He would lose his excellent credit rating. That would be a problem because longer term, Roger wants to buy a home for an estimated $450,000.
We asked Anne Perrault, a money coach at Money Coaches Canada in Ottawa and a licensed insolvency trustee at Perrault and Associates, to look at Roger’s situation.
What the expert says
Roger owes $29,500 on his credit line, $1,000 on credit cards, $69,000 for student loans and $15,000 for a car loan, for a total of $114,500. Ms. Perrault analyzes Roger’s options, starting with bankruptcy. “Based on his net income, Roger would be required to pay a portion of his ‘surplus income’ – a calculation based on income, expenses and family size – to his bankruptcy estate. In Roger’s case, that would amount to $25,704 over a period of 21 months,” she says. People with surplus income are considered to be bankrupt for 21 months before they can be discharged. The $3,000 in his bank account would be seized but the LIRA would not.
He could continue to pay the car loan if the insolvency trustee and the lender agree, or he could relinquish the car. In that case, the balance owing would become a claim in the bankruptcy estate and be written off along with the line of credit and credit card balances. Roger would still be liable for the balance of his student loans because his last day at school was less than seven years ago. (A discharge from bankruptcy releases you from your obligation to repay your student loans if you filed for bankruptcy at least seven years after the date you ceased to be a part or full-time student.) His credit rating would plunge from R1 to R9 for 21 months – the duration of the bankruptcy – plus six years. To restore his rating, he would need to establish unblemished credit from three credit sources for two years after being discharged, Ms. Perrault says.
Alternatively, Roger could make a proposal to his creditors to pay $500 per month over 60 months, for a total of $30,000. He would be able to keep his cash and car, as well as the LIRA. His credit rating would decrease for the time of the proposal terms to R9 and then to R7 for an additional three years. He would need to establish unblemished credit from three sources for two years after the proposal was fulfilled.
Another alternative would be to try to settle his bank line of credit, which means the bank would agree to write off a portion of the loan. But this, too, will hurt his credit rating, she says. He would also have to come up with some cash. If, for example, they agreed on a 50-per-cent settlement, Roger would have to pay a lump sum of $14,750, “which he does not currently have.”
Rather than risk hurting his credit rating, Roger could ask the bank to lower the interest rate. A decrease of only three percentage points could lower his monthly principal and interest payments by $40, saving him $2,500 over the next five years. Roger cannot draw on his LIRA because the funds are locked in until he is 55.
What Ms. Perrault suggests: That Roger not declare bankruptcy or do anything else that would hurt his credit score. Instead, he pays off the credit line. “If he wanted to pay it off in the next five years at the current interest of 8.5 per cent, it would cost him $605 a month.”
He could ask the bank to reduce the interest rate on the credit line. He should pay off his credit cards over the following three months.
She suggests he continue paying the car loan at a rate of $420 a month until it is paid off in full in the spring of 2022. The credit line would be paid off by August, 2022, and the student loans by May, 2028.
In the meantime, she suggests Roger start contributing to a registered retirement savings plan this month. By May, 2028, he would have $47,900 in his RRSP, from which he could borrow up to $25,000 under the federal Home Buyers Plan. Based on his current income of $75,000, Roger could afford a home valued at $325,000, Ms. Perrault says. He could borrow $21,125 from his RRSP to cover the 5 per cent or $16,250 down payment plus closing costs.
The person: Roger, 31
The problem: Should he declare bankruptcy to get out from under his debt load?
The plan: Avoid doing anything to hurt his excellent credit score. Pay off the debts over time, save to an RRSP and plan to buy a less expensive home.
The payoff: The borrowing power he will need to buy a place of his own.
Monthly net income: $4,600
Assets: Cash $3,000; LIRA $50,000. Total: $53,000
Monthly outlays: Rent $1,400; car loan $420; car insurance, fuel $300; groceries $400; clothing $250; credit line $300; dining, drinks, entertainment $400; phone $90. Total: $3,560 Surplus $1,040
Liabilities: Credit line $29,500; credit cards $1,000; student loans $69,000; car loan $15,000. Total: $114,500
Editor’s note: Our expert, Anne Perrault, is a money coach at Money Coaches Canada in Ottawa and a licensed insolvency trustee at Perrault and Associates. An earlier version of this article incorrectly identified her as a licensed insolvency trustee at Money Coaches Canada.
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