What are the Risks of a Consumer Proposal?

Disadvantages of Filing a Consumer Debt Proposal

In the face of mounting debts, a consumer proposal can be a lifeline. However, diving headfirst into this debt relief option without understanding its potential downsides can lead to unexpected surprises. This comprehensive guide will explore the potential risks of a consumer proposal, so you can make an informed decision.

Introduction

Before plunging into the specifics, let’s briefly touch upon what a consumer proposal is. A consumer proposal is a legally binding agreement between a debtor and their creditors, facilitated by a Licensed Insolvency Trustee (LIT). The debtor agrees to pay back a portion of their debts over a specified period, and in return, the creditors agree to forgive the remaining balance. Now, let’s delve into the potential risks.

The Impact on Your Credit Score

One of the primary risks of a consumer proposal is the negative impact it can have on your credit score. When you file a consumer proposal, it signifies to creditors that you are unable to repay your debts in full, which can damage your credit score. This record remains on your credit report for a maximum of six years. Despite this, it’s crucial to remember that high debt levels can also negatively affect your credit rating, and getting out of debt is the first step towards rebuilding your credit.

Loss of Credit Cards and Lines of Credit

Once you file a consumer proposal, you will be required to forfeit all your credit cards, and any lines of credit you have will be cancelled. This can be a significant adjustment, especially if you are accustomed to relying on credit for your daily expenses. However, after a year of filing a consumer proposal, you may be eligible to apply for a new credit card, depending on your credit rating at the time of application.

Ineffectiveness Against Secured Debts

Another limitation of a consumer proposal is that it only covers unsecured debts. This means that secured loans, such as car loans or mortgages, cannot be included in a consumer proposal. If you can afford the monthly payments for these secured debts, you can continue to pay off these loans separately. However, if you can’t afford the payments, you have the option to surrender the assets to the creditors.

Potential for Creditors to Reject Proposal

While rare, there is a possibility that your creditors may reject your consumer proposal. Creditors have 45 days to vote on your proposal, and if more than 25% of them (by dollar value) ask for a meeting and more than half of the claims vote against your proposal at the meeting, it can be rejected. However, most LITs are experienced at preparing proposals that are likely to be accepted by the creditors, and if a creditor does not accept your initial offer, they often make a counteroffer.

Debt Limitations

Consumer proposals come with debt limitations. In Canada, you can only file a consumer proposal if you owe less than $250,000 excluding the mortgage on your primary residence. If your debt exceeds this limit, you will have to file a Division I proposal, which comes with additional risks. If creditors reject a Division I proposal, you are automatically bankrupt, unlike with a consumer proposal.

The Power of Large Creditors

As the weight of a creditor’s vote is proportional to the amount you owe them, creditors with large claims can demand a higher payout. This can influence the terms of your proposal, potentially requiring you to offer more for the proposal to be accepted. Working with a knowledgeable LIT who understands creditors’ expectations can be beneficial in these situations.

Non-Eligible Debts

A consumer proposal does not cover all unsecured debts. Certain debts, such as those due to fraud, child support or alimony payments, court fines, and student loan debt (if you have not been out of school for seven years), cannot be discharged through a consumer proposal. This is an important factor to consider when evaluating the suitability of a consumer proposal for your situation.

Risk of Proposal Annulment

If you miss three months’ worth of payments, your consumer proposal can be annulled. When your proposal is annulled, your debts return, and you lose the protection against collection activity provided by the consumer proposal. This means your creditors can resume calling, suing, or garnishing your wages.

Weighing the Alternatives

A consumer proposal is not the only solution for debt relief. Other options include debt consolidation, credit counselling, and bankruptcy. It’s essential to understand the pros and cons of each alternative and consult with a LIT to determine the best solution for your financial situation.

Conclusion

While a consumer proposal can provide significant relief from overwhelming debts, it’s important to understand the potential risks involved. By considering these points and consulting with a LIT, you can make an informed decision about whether a consumer proposal is the right choice for your financial circumstances.

Remember, the intent of this guide is to provide you with the information you need to understand the risks associated with consumer proposals. It’s always advisable to seek professional advice before making any significant financial decisions. If you’re struggling with debt and considering a consumer proposal, we recommend reaching out to a LIT to discuss your options.

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