It may be hard to believe, but there are companies that offer to loan you money to pay out your consumer proposal. The rationale is simple: the sooner you pay off your consumer proposal, the sooner you can begin to rebuild your credit.
There is some truth in that statement. A consumer proposal remains on your Equifax credit report for three years after you finish the payments, so by paying it out early you get a jump start on beginning to improve your credit score.
In addition, so the argument goes, the new loan also improves your credit score, because it is new credit you received after your consumer proposal started.
Sounds good, so what’s the problem? The problem can be summarized in one word: interest.
Interest Payments Add Up
With a consumer proposal there are no interest payments. With a loan, obviously, you are paying interest.
One company that offers these loans offers an example on their website. In their example they assume you will offer a lump sum proposal to your creditors of $10,000. You borrow the $10,000, pay the proposal immediately, and then pay off the loan over four years.
Sounds great! But is it really?
The consumer proposal drops off your credit report in three years, you have a new loan over four years, so your credit looks good! Here’s the catch: You are making payments of $331.52 per month for four years, for total payments of $15,912.74 on a $10,000 loan. I did the math, and that works out to an annual interest rate of 24.99%!
That’s higher than the interest you were paying on your credit cards that caused you to get deep into debt in the first place.
This company says that by getting a loan to make a lump sum proposal you can negotiate a better deal with your creditors. In their example the debtor has $48,000 in unsecured debts, and has two proposal options:
- Offer $280 per month over 5 years, for total payments of $16,800, or
- Offer a $10,000 lump sum proposal, financed by the loan described above, where you pay $331.52 for 4 years, or $15,912.74 in total.
Presented that way it sounds like a good deal: get the loan, only pay for four years instead of five, pay less, and get a better credit score. Beautiful.
What is the Downside (…Besides Paying More)?
Here’s the flaw: the Big Banks often want something in the range of 35 cents on the dollar in a consumer proposal, so paying $280 for five years on $48,000 in debt makes sense; that’s 35 cents on the dollar. Offering a lump sum proposal of $10,000 on $48,000 in debt is only just over 20 cents on the dollar, which may not be acceptable to the bank.
I understand the thought process: the bank gets all of their money up front, so with the “time value of money” they should be willing to accept 20 cents today, as compared to 35 cents over the next five years. That sounds logical, but having personally supervised over 10,000 consumer proposals in my career I can tell you for certain that logic is not always the deciding factor in many proposals. Many banks and credit card companies want to achieve a certain recovery threshold, regardless of whether it is a lump sum or a five year proposal. That’s just the way it is.
Here’s my advice:
The solution to debt is NOT more debt. (I know the government of Canada keeps trying that solution, but trust me, it doesn’t work).
Deal with a reputable consumer proposal administrator, and ask them to explain what proposal they expect will be accepted by your creditors. If you have access to borrowed money (perhaps from family) and you want to use it to make a lump sum proposal, that is your choice, but be sure you understand the full costs of the interest you will be paying.
If your consumer proposal administrator suggests that you get a loan to prepay or pay off your proposal, ask them if they are getting any “kickback” or referral fee from the loan company. If they are, run away.
Instead of borrowing, focus on cutting your expenses to free up cash to pay off your proposal as quickly as possible, so you get the best of both worlds: a paid off proposal, and no excessive interest charges.
A consumer proposal should offer you a fresh start, not a way to get back into debt.