How Consumer Proposal and Bankruptcy Affect Your Credit Score In Canada

Download our free step-by-step guide: Starting Over After Consumer Proposal or Bankruptcy.

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We all know that consumer proposal and bankruptcy don't do your credit score any good. But do you know exactly how it will affect your credit score in Canada and for how long? Let’s dig into it.

What is Consumer Proposal and Bankruptcy?

A Consumer Proposal is "a legally binding debt settlement agreement to repay your creditors a percentage of what you owe in exchange for full debt forgiveness." Bankruptcy on the other hand is "a legal procedure in which you assign (or surrender) your property to a Licensed Insolvency Trustee as part of a process that relieves your debts".

If you find yourself buried under a mountain of debt that is impossible to pay back, bankruptcy might be the solution you’re considering. It will sweep away most of that debt, with a few exceptions such as student loans, child support, and fines. You’ll be protected from legal action relating to your debts, some assets will be protected, and if you had already been experiencing wage garnishes related to your debts, they’ll cease once you’ve declared bankruptcy. In short, you get a do-over. It sounds like a good deal, but the toll it takes on your credit is huge.

Consumer Proposal as an Alternative to Bankruptcy

There is an alternative to bankruptcy, though, that’s not quite so harsh. It’s called a consumer proposal and you’ll still have to pay down some of your debts. You’ll start the consumer proposal process by making a repayment proposal - you’ll suggest a doable amount that you can pay back, rather than the full amount you owe, and your creditors will review it and accept it or deny it. If it’s accepted, you’ll make static monthly payments until your proposal is complete. After it’s complete, it will appear on your credit report for three years, during which it doesn’t quite pull your score down as low as a bankruptcy would, but it still gives it a good cutting down.

Bankruptcy and Your Credit Score

Choosing bankruptcy means your credit report will show it for up to seven years. If it’s your second bankruptcy, that turns into 14 years from the date you are discharged. During this time, any creditors considering lending to you are likely to see you as a high risk borrower. Your credit rating will take a severe hit, knocking it right down to the bottom of the credit score scale. It will continue to drag your credit score in Canada down until that seven year period is up. The good news is, you can take positive steps to mitigate the impact of the negativity on your credit score. Check out this infographic for more details!

No New Credit

You’re going to have to do some serious work to drag that credit score out of the gutter. Any loans, lines of credit or credit cards you obtain will either have to be co-signed for or secured, meaning you put the funds down first, as insurance for the lender. It can take some individuals upwards of a decade to recover from bankruptcy. During all of that time, you’ll have trouble booking travel, renting cars, buying a home, and the list goes on.

Is Bankruptcy right for me?

The first question you need to ask yourself, therefore, is, do I need to declare bankruptcy or is there a better option for me? Make sure you know what you're getting into. It's important that you understand whether it's the best option for you, your family and your collective financial future. Declaring bankruptcy, while the only option for some, may be a knee-jerk reaction for others, without first exploring other options.

Step 1: Arm yourself with the facts about bankruptcy

• A bankruptcy stays on your credit report for 6 years following discharge. Discharge refers to being released from the legal obligation to repay debts that existed on the day the bankruptcy was filed. It effectively acts as an anchor to your credit score that entire time.
• If it’s your second bankruptcy, that turns into 14 years from the date you are discharged.
• During this time, any creditors considering lending to you are likely to see you as a high-risk borrower. Your credit rating will take a severe hit, knocking it right down to the bottom of the credit score scale. It will continue to drag your credit score in Canada down until the 6-year period is up.

Step 2: Know when NOT to declare bankruptcy

Bankruptcy may seem like an easy way out, a way to get a do-over, however, a bankruptcy is only beneficial for a very small amount of people. It isn't always the best option, and it might not be the right one for you. Before doing anything, double check that none of these 5 reasons to not consider bankruptcy apply to you.

1. Most of Your Debt Is Student Loans

In Canada, student loans cannot be forgiven by bankruptcy. If what you owe is mostly to student loans, and you declare bankruptcy, you’ll still owe a good portion of what you did before, so you won’t be gaining anything, only losing, by declaring bankruptcy in this situation.

2. Most of Your Debt Is Cosigned

If you've taken out a loan or a line of credit and your parents or another loved one has cosigned for it, they will be on the hook for the amount owing on the account if you declare bankruptcy. Will your relationship survive that? Will you be expected to pay them back the amount they paid off? Once again, you may find yourself in the situation of having to pay down the majority of your debt despite declaring bankruptcy.

3. You're Unwilling to Sacrifice to Pay Back Your Consolidation Loan

If you've looked into a consolidation loan and you figure you can't make the payments but are not willing to sacrifice non-necessities from month to month, bankruptcy is going to be difficult for you. When you declare bankruptcy, you have to report your expenses and income to your trustee each month until the discharge date. You will be expected to live on a budget. If you can't do it for a consolidation loan, you won't be able to do it for your bankruptcy trustee.

4. You Have the Ability to Pay Off Your Debt

If you can afford to pay down your debt after making some lifestyle changes but are not willing to, then bankruptcy is not for you. The thing is, you will be expected to make those exact lifestyle changes during bankruptcy. Reports to your trustee will show him or her everything on which you spend your money. Whether you do it now without the penalty of bankruptcy to be able to pay down your debt, or you do it with the scar of bankruptcy, you're going to have to make those changes.

5. You Have Not Researched Other Options Such as a Consumer Proposal

If your first impulse was to jump on bankruptcy and you have not spoken to a credit counselor of any kind, you're not ready to make this decision. Get yourself informed first. Find out how consumer proposals and consolidation loans work. Go through your expenses with a fine-toothed comb to identify changes you can make. Explore the possibility of having family help you pay down your debt instead, and then paying those family members back. You'll save your credit; you'll save yourself the hassle of having a trustee rummage around in your personal affair for a year and you'll save yourself the stress.

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While a consumer proposal or bankruptcy can cause a lot of stress and anxiety, what’s in the past cannot be changed. But with the right habits and a few tools to help you along the way, this could be the fresh start you need, and the first step on your journey to financial stability. Download our free step-by-step guide: Starting Over After Consumer Proposal or Bankruptcy.