By Doug Hoyes, Founder and Trustee, Hoyes, Michalos & Associates
You have debts, so you are considering the obvious permanent legal solution: Declaring bankruptcy or filing a consumer proposal. All of your debts will be eliminated, and you can get on with your life. But is it really that simple?
The decision to take the formal legal step of filing personal bankruptcy or a consumer proposal should not be made lightly. There are some benefits, but there are also costs to be considered.
Benefits of Formal Insolvency
The benefits of formal insolvency are obvious. Most of your unsecured debts are eliminated, including credit cards, bank loans, and even taxes owed to the Canada Revenue Agency. The phone calls and collection actions stop, and you have peace of mind.
Once you are out of debt, you can begin to rebuild your finances. Your monthly cash flow improves, since you no longer owe debt payments, making it easier to make ends meet and even begin to save.
Costs of Bankruptcy
There are of course costs to be considered as well. Bankruptcy isn’t free. You will generally be required to make a monthly payment to your bankruptcy trustee (based on your income), and you risk losing certain assets. There will be a note placed on your credit report for a minimum of six years after your bankruptcy is completed, so in addition to the out-of-pocket costs of bankruptcy, your ability to borrow in the future may be severely impacted for a period of time.
You can borrow after bankruptcy, but only after you have taken steps to rebuild your credit, and only generally if you have a sufficient income and a down payment or security deposit.
Weigh the Pros and Cons
So what should you do? Is it better to simply deal with the debt on your own and avoid bankruptcy? Avoiding bankruptcy is generally the preferred option, but whether or not you need to file for bankruptcy depends on your specific circumstances.
If you have a significant amount of debt, it may be mathematically impossible to ever repay it on your own. If your net pay is $2,000 per month and you have $50,000 in unsecured debt, it would take over two years to repay your debt in full if you had no living expenses and the loans were interest free! That’s unrealistic for most people.
If you have assets that can be liquidated to pay the debt, you can sell your assets or refinance your home in order to avoid bankruptcy. If, however, you have limited or no assets, bankruptcy becomes the more plausible option.
If you are threatened with legal action such as a wage garnishment, a legal solution such as bankruptcy may be necessary. In fact, a significant number of the personal bankruptcies I have filed over my career were initiated by the debtor’s realization that if they did nothing they would end up with a wage garnishment. For many people, that’s the deciding factor: If your debt has become a legal problem, a legal solution is required. A wage garnishment will not stop until it’s paid in full unless you get legal creditor protection in the form of a bankruptcy or consumer proposal.
So how do you decide if you can deal with your debts on your own, or if formal insolvency is required? If it will take you many years to repay your non-mortgage debts on your own, or if you are threatened with legal action, a bankruptcy or consumer proposal should be considered. In Canada, a bankruptcy or consumer proposal can only be filed through a licensed bankruptcy trustee. You don’t have to make the decision on your own – consult a trustee to talk about all of your options.