What’s the difference between consumer proposals and debt consolidation in how they affect your credit score? I asked three debt experts but before we get into the credit score details, what is a consumer proposal and a debt consolidation?
Stacy Yanchuk Oleksy, CEO of Money Mentors, an Alberta-based non-profit credit counselling organization says a consumer proposal is an insolvency solution that allows a consumer to pay back a portion of their debt by making monthly payments. Consumers can typically keep their assets and avoid bankruptcy. You can expect to pay 20-50 per cent back of what you owe.
“A debt consolidation is a broad term to describe various debt repayment solutions,” she says. “Financial institutions offer debt consolidation loans whereby a consumer consolidates all their unsecured debt into a monthly loan that is paid off within a given period.”
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There are fees associated with either option, says Doug Hoyes, co-founder of Hoyes, Michalos & Associates and a licensed insolvency trustee. He says that in a consumer proposal, some of the money the debtor is paying goes to the trustee.
“They don't get the full amount of the money you're paying. It's a complicated formula for how it works, but basically, in a consumer proposal, the trustees' fees are set by the government.” They include: A filing fee of approximately $100 paid to the OSB,
- Counselling fees of $85 for each of two mandatory credit counselling sessions
- Proposal fees to the consumer proposal administrator (trustee) of $1,500 plus 20 per cent of creditor distributions
- A levy of 5 per cent of creditor distributions payable to the Office of the Superintendent of Bankruptcy (OSB)
With a debt consolidation loan, Hoyes says the debtor pays interest on that loan. It could be as much as 30 per cent on an unsecured loan, depending on your credit history. A secured loan (such as a home equity line of credit ) has a much lower interest of seven to 14 per cent. When you calculate the interest you would pay at typical credit card rates of 19.99% to 29.99%, it becomes clear that a secured debt consolidation loan can be advantageous.
Another approach to debt consolidation involves transferring the debt to a low-interest credit card (9.99% to 12.99%). However, this typically requires a good credit score, and even then, the credit limit might be too low to transfer all your debts to a single card.
“So when you're trying to decide which one you do, what's more important, the amount of money I pay out, or the impact on my credit score?” says Hoyes. He says if you have a lot of debt and your credit score is bad, around 580 or lower, depending on your debt and income and you can’t rent an apartment, then the consumer proposal is the preferred option.
“Even though your credit score will temporarily still be bad, it's a lot less expensive than paying back in full plus interest for the debt consolidation loan,” he says. “On the other hand, if I've got pretty good credit now and I've got the ability to borrow the money and pay it back then that's what you should do. Your credit score will be enhanced as a result.”
Yanchuk Oleksy from Money Mentors explains that debt consolidation is a great solution when a consumer can amalgamate their debts into one payment and have the income to support monthly payments. This is a better solution in terms of protecting one’s credit, assuming the paid-off products consolidated into the loan are closed.
“Consumer proposals are also good solutions when a consumer has either too much debt or not enough income to afford a consolidation loan. There are legislated levies and fees that must be paid to the licensed insolvency trustee.”
No matter which option you chose, your credit score will be affected, says Susan Eisner, CEO of SolveYourDebts, a member agency of Credit Counselling Canada.
When it comes to common misunderstandings about both solutions, Yanchuk Oleksy says that what is often misunderstood with a debt consolidation loan is how easy it is to get “back into trouble” with debt. If we are not diligent about closing products that were included in the loan and not acquiring new debt, we can easily get into double the debt.
With consumer proposals, she says, “The most common misconception [concerns] the fact that it is a legal insolvency solution which will be on your permanent record. Even after it comes off your credit report, it will remain on permanent records, which are available for the public to see.”
