True or false: Filing for bankruptcy or a consumer proposal will ruin your credit forever

For this week’s Reality Cheque, we’re looking at the popular misconception that filing for bankruptcy spells personal financial doom.

If “debt” is a four-letter word, “bankruptcy” has an even worse reputation, literally synonymous with “ruin” (as thesaurus nerds know). So, let’s clear up the concept: Bankruptcy is a legal process that enables people with insurmountable debts to eliminate most of these debts. The process falls under the category of insolvency proceedings, which also include consumer proposals (more on the differences later).

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“Insolvency proceedings are for the honest but unfortunate person who finds themselves in a situation they can’t get out of. So, people should lean on it if they need it,” says Bridget van Wyk, a B.C.-based licensed insolvency trustee (LIT) and partner at the firm Farber. Filing for insolvency might be “short-term pain, long-term gain,” she adds, because rebuilding credit post-bankruptcy can be better than struggling with debt for an eternity.

In Canada, insolvency proceedings are governed by the Bankruptcy and Insolvency Act, which means there are a lot of very specific rules about how it all works. Here’s the rundown if you’re considering this route.

Call in an expert—but beware of shady “debt consultants”

“If you are in financial difficulty, you should go directly to a licensed insolvency trustee. The vast majority of them will provide a free consultation,” says Victor Fong, LIT and founder of the Toronto-based firm Fong and Partners. LITs are federally regulated professionals who specialize in debt-relief options, and they’re the only experts authorized to help you through a consumer proposal or bankruptcy.

Don’t make the mistake of going to a “debt consultant” or “debt advisor,” because these are unregulated titles anyone could claim. They’re not credentials. “For many years, a lot of people, particularly from cultural communities, would go to an intermediary, who would introduce them to a licensed insolvency trustee,” explains Fong. “And they would pay that intermediary—they call themselves debt consultants—up to thousands of dollars for introducing them to a trustee.”

You don’t need to pay for a referral; just head right to an LIT. Like their credentials, their fees are also federally regulated.

Know the differences between a consumer proposal versus bankruptcy

If dealing with debt makes you feel like Sisyphus pushing that boulder up a mountain over and over again, you have options. These include filing for a consumer proposal or bankruptcy. Here are some of the key differences:

Filing for a consumer proposal

• This is basically a debt settlement: you agree to repay your creditors some of what you owe, and the rest is forgiven.
• This option is for people with $1,000 to $250,000 in unsecured debts (your mortgage doesn’t count).
• An LIT will negotiate with creditors on your behalf.
• You can reduce your debt by up to 80%.
• The remaining debt will be paid monthly, over a period of up to five years, with no interest or fees; the monthly amount is based on what you can afford.
• You can usually keep your assets, such as RRSPs (registered retirement savings plan) and cash savings. 
• A consumer proposal causes an immediate drop in your credit score, with debts rated R7. (On the scale, R1 equals perfect credit, while R9 signifies bankruptcy.)
• A consumer proposal stays on your credit report for six years after filing, or for three years after you’ve fulfilled the agreement (whichever comes first). 

Filing for bankruptcy

• Bankruptcy is a last resort for those who can’t repay their debts.
• This option is for those with at least $1,000 in unsecured debts; there’s no ceiling.
• You go through a process to legally discharge (i.e. eliminate) your eligible unsecured debts, such as credit card debt, unsecured loans and lines of credit.
• Bankruptcy won’t wipe out secured debts, however, such as your car loan and mortgage. 
• You will lose some assets, which are typically sold to repay creditors.
• The process for a first-time personal bankruptcy usually takes nine months.
• Bankruptcy causes an immediate drop in your credit score, down to the lowest rating (R9).
• After your debt is wiped, the bankruptcy stays on your credit report for six to seven years (depending on your province). 

To figure out which option is better for you, it’s always best to speak to a licensed insolvency trustee.

Take the slow but steady approach to rebuilding credit

Around six years ago, Lindsey Costard was a sole proprietor of a small business, hoping to buy a home, while also grappling with a lot of debt, both consumer spending and business tax-related. “It just sort of just kept snowballing and snowballing,” explains Costard, now a yoga teacher based in Nova Scotia. Eventually, she met with an LIT to weigh her options and decided on a consumer proposal. “It was very scary for me, thinking about how my credit’s going to be ruined,” she recalls. Thankfully, rebuilding credit was “not necessarily hard, but you have to be patient.”

While this may sound counterintuitive, getting a secured credit card is one effective strategy for rebuilding your credit score. The key is to use it responsibly, establishing a pattern of on-time payments. Your good behaviour is then reported by the card provider to Canada’s credit bureaus, TransUnion and Equifax, improving your score with time.

This kind of card doesn’t require a credit check, as applying for other credit or loans does. So there’s no hit on your credit score. Instead, you put down an upfront security deposit, which becomes your credit limit. That’s what Costard did, starting with a deposit of $250, and increasing it gradually over time. (Don’t confuse secured credit cards with prepaid cards, although they sound similar. Prepaid cards don’t report to credit bureaus, so they can’t help you rebuild credit.)

“If you do have a secured credit card, keep the balance below 30% of the credit limit,” recommends van Wyk. “And avoid applying for multiple new credit cards in a short period of time. Once you’re discharged (from bankruptcy),” she says, you can apply for other cards, but “do it staggered.”

“I usually advise people to follow the 2-2-2 plan,” says Fong. That means getting two secured credit cards, with a credit limit of $2,000 per card, if you have access to those funds, and being consistent with your repayment history for two years. “That’s the most efficient way to rebuild your credit.”

If you don’t have access to $4,000 to secure the two cards, it’s worth starting with whatever you have available and adding to your card until you reach Fong’s recommended credit limit. After two years, Fong says, you should notice a “significant positive change” in your credit score. Be diligent with paying all your debts on time, including your car loan, phone bill and utility bill.

Work on developing healthier money habits

Costard kept an eye on the progress of her credit score, while changing the way she handled her personal finances. “The big lesson was learning how to live within my means,” she says. “We really got comfortable with using a budget calculator to the dollar.” She took steps to ensure she paid debts on time, setting up automatic bill payments, as well as calendar alerts reminding her to check account balances.

Happily, her insolvency was very recently removed from her official record. “I feel like my credit score now is even better than before insolvency,” Costard says, “and I have all these much more positive money habits.”

Read more from this issue of The Get:

1. Boomerang kids in Canada: why they never move out 
2. Chef Mary Berg on how to slash your food bill–and still make a damn-good dinner
3. How to write a Facebook Marketplace listing that actually sells your stuff
4. Is a heat pump worth it? What’s the cost for Canadian homes?