Consumer Proposal vs Debt Settlement

There are many companies that offer debt settlement services, where they negotiate a settlement with your credit cards and other debts.  They will typically offer a reduced “cents on the dollar”, perhaps as low as 20% of the amount owing. How do you know if it’s a good deal for you?

Why Would Creditors Accept a Debt Settlement?

If you pay your debts each month, and if you were to call up Visa and say “I only want to pay back 20% of what I owe”, they will laugh at you. They want all of their money.

However, if you get laid off and are out of work for a few months and get behind on your payments, Visa may be more willing to accept a deal. The math is simple for a creditor: they want to get as much as possible. If you have not paid for many months, and have no assets, and if they don’t know where you work so they can’t garnishee your wages, they have few options for collection.

In fact, in many provinces there is a Limitations period on lawsuits.  For example, in Ontario, a creditor must start legal action within two years of when you last paid them, or else they lose their right to sue.

So, if the bank hasn’t received any payments for 18 months and they realize that “time is running out”, and they don’t have any other way to collect from you, they may be willing to accept a debt settlement of 20 cents on the dollar, because it’s their only option.

Three Keys to a Successful Debt Settlement

  1. First, the chances of success are much greater if the debt is old and in arrears, ideally for 18 months or longer.  If you made a payment yesterday, it’s unlikely they will accept a deal today.
  2. Second, to get a deal you need a lump sum of money. If the collector agrees to a $5,000 settlement, they want $5,000 today, not $100 per month for 50 months.
  3. Third, the creditor must be willing to make a deal.  Credit card companies might make a deal.  Canada Revenue Agency won’t, so a debt settlement will only work with certain creditors.

How Debt Settlement Companies Work

Now that you understand the process, it is easy to understand those ads you hear on the radio promising to “settle your debts for up to a 70% discount”. You contact the debt settlement company and tell them that you owe $40,000 on credit cards and bank loans. They do the math, and they believe they can get the creditors to accept 20 cents on the dollar, or $8,000, so they tell you “no problem, send us 30 cents on the dollar, or $12,000, and we can make a deal”.

You are happy because $12,000 is less than $40,000, and the settlement company is happy with their profit of $4,000 on the deal.

When Problems Arise

If you are behind on your payments you probably don’t have $12,000. This is where the process of most debt settlement companies begins to unravel. If this is the case they will often take one of three possible approaches:

  • They may advise you to start saving the money, and to call them when you have it. Unfortunately if it takes you two years to save the money, you will spend two years dealing with collection calls and potential lawsuits and wage garnishments.
  • They might also suggest you start making payments with them and they will put the money aside for you. If they don’t contact your creditors and the arrangement falls apart, you have made payments for nothing.
  • They may refer you to a trustee to file a consumer proposal anyway, after collecting a fee for ‘helping’ you assess your options.  In truth, you should never need to pay a referral or processing fee to see a trustee to file a proposal.

It general unless your debts are already old (which is necessary to get a big discount), and unless you already have access to a lump sum of money, a debt settlement won’t work.

Why a Consumer Proposal is Different

In contrast, with a consumer proposal your debts don’t need to be old, you don’t need a lump sum of money, and virtually all unsecured creditors are included, including Revenue Canada.  Even better, with a consumer proposal you negotiate the settlement and terms up front. Once the proposal is accepted (generally 45 days after filing), you know exactly what you are required to pay.  No need to “wait for two years” in the hopes that the creditors will accept your deal.

While there are very specific cases where a debt settlement is a good option, in the vast majority of cases a consumer proposal offers a legally binding settlement with payments over time (no upfront lump sum required) and the ability to deal with all creditors.

If you are considering debt settlement, contact a Consumer Proposal Administrator. We can help you understand the risks and compare the cost of each program. There is no charge to ask a question or come in for a consultation. Contact us today – we can help you choose the best option.