Debt Settlement in Canada
Setting the right expectations to avoid complications.
Debt settlement is a solution that allows you to get out of debt for a percentage of what you owe. There are several ways to do this, including enrolling in a program with a private company that negotiates on your behalf. However, this option has some risks and isn’t guaranteed to work. Here’s what you need to know about debt settlement in Canada.
What is debt settlement?
Debt settlement allows consumers to get out of debt without paying back the full balance owed. You reach an agreement with a creditor where you pay back a portion of an account and then the remaining balance is discharged.
There are three basic ways to settle a debt. You can:
- Negotiate a settlement directly with a single creditor or debt collector.
- Enroll in a debt settlement program through a private, for-profit company to settle multiple debts.
- Work with a Licensed Insolvency Trustee to set up a consumer proposal.
The last option is the most widely accepted and most likely to succeed. The Bankruptcy and Insolvency Act established the formal process to settle debts with the help of a trustee. The trustee reviews your finances to determine what you can reasonably afford to pay off. Then you and your creditors sign a formal agreement.
Debt settlement outside of consumer proposals
Given that Canadians have the option of working with a Licensed Insolvency Trustee, trying to settle debt outside of that structure can be problematic. Creditors may be unlikely to accept settlement offers.
Negotiating on your own
In some cases, you may be able to negotiate a settlement yourself with one individual creditor or collector. Debt collectors, in particular, are more likely to negotiate because they typically purchase debt from the original creditor for less than the balanced owed Thus, accepting a percentage of the balance still allows them to yield a profit.
If you have a debt in collections and a collector is hounding you for payment, there’s nothing wrong with trying to negotiate. See if they will accept an amount that’s less than the full balance due. If you decide to try this, make sure all negotiations are conducted in writing. Do not make any payment until you have a signed agreement from the collector.
Working with a debt settlement company
There are private companies in Canada that offer to help consumers settle multiple debts for less than the person owes. Here is how it works:
- The settlement company sets up an account to collect the funds you need to make settlement offers to your creditors.
- In many cases, they may advise you to stop making payments to your creditors and divert the money to raise the funds you need.
- Once there is enough money in the account, they begin making settlement offers to your creditors.
- If a creditor agrees to a settlement, you and the creditor sign a formal agreement.
- Then the funds are withdrawn from the account to pay the creditor.
The biggest challenge with this strategy is that there is no guarantee that it will work when you enter the program. You may stop paying your creditors and ruin your credit, only to find that your creditors are unwilling to accept settlement offers this way.
The result can be that you end up with more debts in collections with even fewer options at your disposal to get out of debt. The only avenues left may be a consumer proposal or bankruptcy.
How does debt settlement affect your credit?
The impact of settlement on your credit depends on which method you use to settle what you owe. Any option will result in a negative R7 notation on your credit report. However, if use a consumer proposal to settle your debt, the R7 notation will only remain for three years from the date of final discharge.
If you settle a debt on your own or you use a debt settlement program, the R7 notation will remain for six years from the date of final discharge. If you settle more than one debt, each will receive the R7 notation.
Also, keep in mind that if you use a debt settlement program and you have any accounts lapse into collections due to nonpayment, those accounts will receive an R9 notation. This is the worst credit rating possible.
How much does debt settlement cost?
If you settle a debt on your own, then the only cost to you is the percentage of the debt you agree to pay. There would be no added fees.
If you get professional support to settle your debts, either from a private company or a trustee, then the cost is relatively high compared with other debt solutions.
If you use a consumer proposal to settle your debt, it costs $1,500 to file plus 20 percent of all future payments.
With a debt settlement program, most companies charge a fee equal to a percentage of the original balance owed on each account. According to the Financial Consumer Agency of Canada, companies may require you to pay upfront and you may still be charged even if the company is unsuccessful at settlement your debt.
What are the alternatives?
If you’re having trouble keeping up with the payments on your debts and aren’t making progress in paying down the balances, the first option to consider is debt consolidation. This option works by combining all your debts into one monthly payment and lowering the interest rate applied to the balance.
The most common way to consolidate is with an unsecured personal loan. If you’re a homeowner, you may also consider a Home Equity Line of Credit (HELOC). However, be careful when borrowing against the equity in your home. If you fall behind on the payments, you could be at risk of foreclosure.
If you can’t consolidate on your own because you have too much debt or your credit score is too low, contact a non-profit credit counselling organization. A trained credit counsellor can help you evaluate your debt and budget to identify the best debt relief option for your needs.
If you need help paying off your debt, you can enroll in a debt management program through the credit counselling agency. This is a professionally-supported repayment plan that works to minimize interest, so you can pay off your debt in 60 payments or less.
With debt management, you will still incur an R7 notation on your credit report for paying back your debt on an adjusted payment schedule. However, the notation only remains for two years from the date you complete the program. What’s more, debt management is a relatively low-cost option compared to settlement.
Since credit counselling agencies are non-profit charitable organizations, they will always provide advice that is in your best interest. This means if debt management is not the right solution for you, they will inform you which option is better. It’s an easy way to get a free professional opinion on your best option for getting out of debt.