Debt Consolidation vs. Consumer Proposal - Which Option Should I Choose?
Debt consolidation and consumer proposals are both great ways to pay off your debt sooner. Debt consolidation can help lower the interest on your debts, while a consumer proposal can stop all interest and may even reduce your total debts. In deciding which option is best for you, you should review your income, credit score, total debts, financial goals and budget to see which option will best help you to become debt-free.
Debt Consolidation and Consumer Proposal
The main difference between a consumer proposal and a debt consolidation loan is that a consumer proposal will immediately stop all interest on your debts and give you 5 years to repay an agreed amount with your creditors. In debt consolidation, you will still be charged interest on your debt, but at a lower interest than before consolidating your debts.
The consumer proposal can also reduce your total debt outstanding by up to 80%, whereas a debt consolidation will not reduce the principal amount owing. By lowering your total debts in a consumer proposal, the monthly payment should be lower than the monthly payments for debt consolidation.
The Advantages and Disadvantages of Consumer Proposal
As with any option, there are always advantages and disadvantages. Let’s first review the advantages of a consumer proposal over a debt consolidation loan:
Can reduce your total debts owing, up to 80%, depending on your income and assets;
Immediately stops all interest on your debts;
Immediately stops all collection actions;
Stops all wage garnishments and judgments;
Can be paid off sooner with no penalties.
The biggest disadvantage of filing a consumer proposal is it will impact your credit rating. Filing a consumer proposal will put an R7 rating on your credit record. This just means you are on a payment plan with your creditors to pay off your debts. This rating will stay for 3 years after the consumer proposal is completed or 6 years from when filed, whichever is first.
Also, you will have to stop doing business with the creditors included in your consumer proposal. For example, if you owe money to a credit card that is the same bank where you hold your bank account, you will likely need to open a new bank account at another financial institution. This is because of the right to offset.
The Advantages and Disadvantages of Debt Consolidation
A debt consolidation has advantages and disadvantages over a consumer proposal. The main advantages are:
Credit rating may not be negatively affected;
Can keep using your same bank account;
The total interest paid each month will be reduced.
Debt consolidation may only be a short-term solution. As the amount of your debt stays the same, you still need to repay the full amount which may still be difficult with a reduced interest rate.
In addition, it can be difficult to qualify for a debt consolidation loan. You will need a good credit score such as 700+ to qualify. Also, this may require adding a co-signor to the loan or securing the loan against an asset. If you can’t repay the debt, your co-signor could become responsible for it.
For example, if after you have a co-signor for the loan, and in the future, you decide to file a consumer proposal, the co-signor will then become responsible for repaying the remaining balance on the loan.
When Should You Choose Debt Consolidation?
The debt consolidation option can be the preferred option when you have good credit to qualify for a loan and have enough income to repay the debts. If you are planning a major purchase such as a house, and don’t want to negatively impact your credit score, then this can be a better option than a consumer proposal.
When Should You Choose a Consumer Proposal?
A consumer proposal may be a better option than debt consolidation in the following cases:
Creditors are likely to accept a reduction of your debs in the consumer proposal;
Your credit score is already low;
Don’t qualify for a consolidation loan;
Wages are currently or about to become garnished;
Consolidation loan payment is too high for your budget;
Not currently paying bills on time.
Having one or more of these factors can make the consumer proposal option better than getting a debt consolidation loan.
Debt Consolidation vs Consumer Proposal Example
Tony has credit card debts of $30,000 with an interest rate of 20% and a line of credit of $10,000 at 10%, for a total debt owing of $40,000. He would like to reduce the interest on his credit card debts so that more of his monthly payments go toward the principal instead of the interest.
Option A - Debt Consolidation
Tony speaks to his local bank and they offer him a line of credit for $30,000 at 10% which he can use to pay off his credit card debts. This option would reduce his monthly interest rate on the $30,000 from 20% to 10%. Tony still needs to repay $40,000 of his debt, but he will have reduced his monthly interest expense and so can pay off the loan sooner as more money each month will go towards the principal portion of the loan.
Option B - Consumer Proposal
Tony speaks to a Licensed Insolvency Trustee and reviews his financial situation. Based on his income and assets, he can offer his creditors $12,000 for his $40,000 of debt. The consumer proposal will require Tony to pay $200/per month for 60 months for a total of $12,000, with no interest charges. The remaining $28,000 owing on his credit cards will be discharged upon his completing the consumer proposal. Therefore, once he files his consumer proposal all creditors can no longer collect from him, as long as the consumer proposal is completed.
The debt consolidation option will reduce Tony's monthly interest incurred on his debts and may not affect his credit rating, but he will still have to pay the full $40,000 plus interest to pay off that debt. With the consumer proposal option, Tony will only pay $12,000 in total to discharge all his debts. While this will negatively impact his credit score, he will have saved over $28,000 which he can save and spend elsewhere.
Debt Consolidation vs. Consumer Proposal FAQs
How long does Consumer Proposal Take vs. Debt Consolidation?
A consumer proposal must be completed within 5 years but can be paid off sooner with no penalties.
For debt consolidation, there is no time limit to repay the debt. You could just make the monthly interest payments forever but is better to also pay down the principal amount each month so the loan will be repaid.
How Will a Consumer Proposal and Debt Consolidation Affect My Credit?
A consumer proposal will have an R7 rating on your credit record for the period to complete the consumer proposal plus 3 years, up to a maximum of 6 years from when filed.
Debt consolidation should have a lower impact on your credit record, as you are paying off one debt and getting another. However, closing a credit card or line of credit can also negatively impact your credit score.
Am I Eligible for a Consumer Proposal or Debt Consolidation?
To file a consumer proposal in Canada, an individual must have at least $1,0000 owed to their creditors and be unable or unwilling to pay their debts as they become due. An individual can file a consumer proposal if their unsecured debts are less than $250,000, excluding a mortgage in the primary residence. You may also be eligible for filing a joint consumer proposal.
There are no restrictions to applying for a debt consolidation loan. However, it is dependent on if the financial institution will offer you the loan by reviewing your credit score, total debts and income.
How Much Does a Consumer Proposal Cost?
A consumer proposal is regulated by the Office of Superintendent of Bankruptcy, so the fees charged by the Licensed Insolvency Trustee are set by them and the same across Canada. The Trustee's fees come from the monthly payments received in the consumer proposal, so there are no additional fees.
If you find you are paying the same amount towards your debts every month, but the total amount owing is not going down, you may want to consider a debt consolidation or consumer proposal to pay off your debts sooner. You will want to review factors such as your income, total debts, credit score, financial goals and budget to see which option will help you become debt-free.
If you are considering debt consolidation and consumer proposals, the Litvack Group would be happy to have a Free Consultation to discuss your financial circumstances and review your options. Contact us today!