Bankruptcy vs. a Consumer Proposal: What's the Difference?

Bankruptcy and consumer proposals are legal options for managing debt in Canada, but they differ in approach. Bankruptcy eliminates most debts through asset liquidation, while a consumer proposal negotiates reduced payments over time without asset loss. Both impact credit ratings but offer distinct paths to financial recovery.

How to Get Out of Debt in Canada

For Canadians facing unmanageable debt, three key options can provide relief:

Bankruptcy: A legal process that eliminates most debts but may involve liquidating assets and impacts your credit score more significantly.

Consumer Proposal: A legally binding agreement to repay a portion of your debts over time, protecting your assets and halting collection actions.

Using Home Equity: If you're a homeowner, tapping into your equity through refinancing, a home equity loan, or a home equity line of credit (HELOC) can consolidate and reduce high-interest debts, offering a viable alternative without legal proceedings.

What is a Consumer Proposal?

A consumer proposal is a legally binding agreement between you and your creditors, facilitated by a Licensed Insolvency Trustee (LIT). You negotiate to repay a portion of your unsecured debts over a period of up to five years, often with reduced payments and no interest. Unlike bankruptcy, you keep your assets while gaining protection from creditor actions.

What is Bankruptcy?

Bankruptcy is a legal process designed to eliminate most unsecured debts when you are unable to repay them. Administered by a Licensed Insolvency Trustee, bankruptcy involves surrendering certain assets to repay creditors. It provides immediate relief from collection actions and garnishments but significantly impacts your credit score.

How Does Bankruptcy or a Consumer Proposal Affect My Credit?

Both bankruptcy and consumer proposals affect your credit score, but the degree varies:

Bankruptcy: Results in an R9 credit rating, the lowest possible, and remains on your credit report for six to seven years after discharge.

Consumer Proposal: Leads to an R7 credit rating, which stays on your report for three years after completion. While both impact credit access, a consumer proposal is less severe.

How Do You Qualify for Bankruptcy a Consumer Proposal?

Bankruptcy: Suitable for those unable to meet debt obligations. No income requirement, but surplus income may affect monthly payments.

Consumer Proposal: Available to individuals with unsecured debts under $250,000 (excluding a mortgage) and sufficient income to make regular payments.

Evaluating your income, debt level, and financial goals helps determine the best option.

Can I Keep My Assets If I File for Bankruptcy or a Consumer Proposal?

Bankruptcy: Certain assets, such as RRSP contributions (except recent ones) and basic household items, are exempt. Non-exempt assets, like high-value vehicles or investments, may be liquidated.

Consumer Proposal: You retain all assets, including your home and vehicle, as long as you continue making secured debt payments.

How Long Do Bankruptcy and Consumer Proposals Remain on My Credit Report?

Bankruptcy: Stays for six years after discharge for a first-time filing and up to 14 years for subsequent bankruptcies.

Consumer Proposal: Remains for the duration of the proposal plus three years after completion.

The longer-lasting impact of bankruptcy underscores the importance of considering alternatives.

How Much Does It Cost to File For Bankruptcy vs. a Consumer Proposal in Canada

Bankruptcy: Costs for bankruptcy vary widely based on your income and assets. The base fee is around $1,800 for a straightforward case, but surplus income rules may require higher monthly payments. For instance, higher earners may need to contribute a portion of their income, increasing the overall cost significantly.

Consumer Proposal: Filing a consumer proposal in Ontario typically costs between $1,500 and $3,500, but these fees are rolled into your monthly payments. For example, if your total repayment plan is $20,000 over five years, the cost is included in your $333 monthly installments.

Both options are regulated, ensuring transparency, and payment plans are tailored to your financial situation.

How Do Monthly Payments Differ Between a Consumer Proposal and Bankruptcy?

Bankruptcy: Payments depend on your income. Higher earners may pay more due to surplus income requirements.

Consumer Proposal: Payments are fixed and agreed upon during negotiations. For example, if you owe $50,000 and settle at $20,000 over five years, your monthly payment would be approximately $333.

How Does Bankruptcy or a Consumer Proposal Affect My Income?

Bankruptcy: Surplus income rules require additional payments if your earnings exceed a threshold set by the government, potentially increasing financial strain.

Consumer Proposal: Your income remains unaffected, as payments are fixed and based on negotiations.

Can I Travel or Leave the Country During Bankruptcy or a Consumer Proposal?

Bankruptcy: Travel is permitted, but you must fulfill obligations, such as providing income statements and attending creditor meetings, before leaving.

Consumer Proposal: No restrictions on travel or relocation.

How Do Bankruptcy and Consumer Proposals Affect My Future Credit?

Both options limit credit access initially, but recovery differs:

Bankruptcy: Longer credit impact and more scrutiny from lenders, requiring significant effort to rebuild creditworthiness.

Consumer Proposal: You may qualify for new credit sooner, as it’s seen as a proactive step to repay debts.

How to Choose Between Bankruptcy vs. Consumer Proposal

Case Study 1: Bankruptcy as the Best Option

John, a single parent, has accumulated $80,000 in credit card debt and personal loans. Due to a recent job loss, his monthly income barely covers basic expenses. He has no significant assets beyond exempt items such as household goods and RRSPs.

Bankruptcy allows John to discharge his unsecured debts entirely, giving him a fresh start. With no surplus income or high-value assets, his costs remain minimal. Although his credit score takes a hit, John avoids unmanageable payments and can focus on rebuilding financially.

Case Study 2: Consumer Proposal for Structured Debt Repayment

Sarah and Mike, homeowners with $100,000 in unsecured debts, want to avoid bankruptcy to protect their home equity. They have stable incomes and can afford to repay part of their debt but need relief from high interest rates.

A consumer proposal enables Sarah and Mike to negotiate repayment of $50,000 over five years, with monthly payments of $833. They retain their home and improve cash flow, demonstrating responsibility to creditors and reducing credit report impact compared to bankruptcy.

Choosing Between Bankruptcy vs. Consumer Proposal

Choosing between bankruptcy and a consumer proposal depends on your financial circumstances, goals, and ability to repay debts. Consulting a Licensed Insolvency Trustee is essential for personalized advice and guidance. With the right support, you can navigate these options and achieve financial stability.