If you’re deeply in debt and struggling to keep up with payments, one solution you may have come across is debt settlement. This form of debt relief involves offering to repay creditors a fraction of what you owe. Should they accept your offer, you can significantly reduce your debt burden. You’ll save money by making smaller monthly payments, incur less interest, and pay off your balance sooner.
Debt settlement can work under the right circumstances, whether you pursue it independently or with outside help. But it also comes with risks, so it pays to know what you’re getting into before you agree to anything.
In this guide, we’ll explain how debt settlement works in Canada and review the various programs and services that can help you achieve it. By the end, you’ll know enough to decide whether it’s worth exploring further as you work to get the debt relief you need.
What is debt settlement?
Debt settlement is a process that allows you to repay your creditor less than what you currently owe. You offer to repay a percentage of your balance, and they write off the remaining amount.
While debt settlement results in your creditor incurring a loss, they’d much rather collect a portion of the debt you owe rather than nothing. As a result, they may be open to bargaining a new repayment schedule, so long as it’s fair and reasonable.
That being said, convincing your lender to forgive a chunk of your debt isn’t as easy as it sounds. They may not be interested in renegotiating the terms you initially agreed to when you borrowed from them. Lenders have other methods they can employ to collect unpaid debts, such as collection calls, wage garnishments, and bank account freezes.
Debt settlement is a legal way to handle debt in Canada. However, the Financial Consumer Agency of Canada cautions against believing in unrealistic promises and high-pressure sales tactics made by some companies offering this service. It warns consumers that they may end up with more debt than when they started (more on this later).
How debt settlement works in Canada
There are three ways you can implement a debt settlement solution in Canada:
- Negotiate a new payment plan directly with your creditors
- Hire a debt settlement company to negotiate with your creditors on your behalf
- Enroll in a consumer proposal with help from a Licensed Insolvency Trustee
What method works best will depend on various factors, such as the level of debt you owe, how much control you wish to exercise over negotiations, and the cost you’re willing to pay.
A consumer proposal is the most popular option, as it’s a federal government program carried out under the Bankruptcy and Insolvency Act (BIA). As a legal process, it’s the safest and most effective way to settle unsecured debts like credit cards, payday loans, and lines of credit. And it offers plenty of other advantages compared to other forms of debt settlement, as you’ll discover later in this article.
Let’s examine the three debt settlement options in detail.
Negotiating a debt settlement directly with your creditor
If you’re confident in your negotiation skills, you can offer a settlement to your creditor directly. Typically, you’d want to contact your creditor to propose a deal once they’ve already written off the balance or transferred your account to a collection agency. Or, you can reach out if your debt is past due, usually by 90 to 120 days. Before that, it’s unlikely that your creditor will be open to a settlement as they may believe you’ll catch up with your payments.
Self-directed negotiation also works best if you have only one type of debt giving you trouble, as it can be challenging to strike deals with multiple lenders. It’s also worth prioritizing working out a settlement with the lender most likely to sue you.
Unless your lender initiates the conversation, you can kickstart the bargaining process by writing a letter to them or contacting them via phone.
No matter how you approach your lender to negotiate a reduction in your debt, it’s critical to document your communication in writing. Ensure you receive a signed copy of the new payment agreement and retain all documents and correspondence related to your discussions. A paper trail will serve you well in a potential legal dispute with your lender.
Hiring a debt settlement company to negotiate with your creditor
Are you uncomfortable dealing directly with your unsecured creditors? If so, there are many debt settlement companies available who can arrange a deal on your behalf. Typically, the process works as follows:
- The debt settlement firm will contact your creditor and offer to pay them a specific amount in return for discharging your debt. This amount will be lower than your existing balance.
- The firm will set up a temporary savings account in your name. Here, you’ll deposit the funds required to satisfy the settlement offer.
- The firm will negotiate with your creditors to discharge as much of our debt as possible.
- Once an agreement is reached, the firm will transfer the funds from your savings account to your creditor. You’ll then be released from any further financial responsibility.
The debt settlement firm will charge you a fee for their services. If they successfully settle your debt, you can expect to pay around 20% to 25% of your original balance. You may also have to pay a monthly maintenance fee as the firm works to reduce your debt.
In Canada, the debt settlement industry is regulated at the provincial level. For example, a firm offering debt settlement services in Ontario must register under the Collection and Debt Settlement Services Act.
Before considering working with a private debt settlement firm, research its background to determine if it’s reputable, trustworthy, and affordable.
The risks of working with a debt settlement company
Hiring a debt settlement company can save you plenty of time and hassle. But, there are risks to pursuing this strategy for discharging your debt. Enrolling in a private debt settlement program can leave you owing more money than you did previously. And, at that point, you may have fewer options to resolve your debts.
There’s no guarantee of a settlement. Always be cautious about companies that promise spectacular results; there’s no guarantee that their tactics will produce results. They may mislead you into thinking they possess extraordinary powers to reduce your debt when, in fact, the law severely limits what they can do. Furthermore, suppose your creditors believe they can collect more through other avenues. In that case, they’re unlikely to cooperate with a debt settlement company in the first place.
Interest charges don’t stop. Your creditors can continue to charge you late penalties and interest even if you start working with a debt settlement company. And things can get worse if the debt settlement company tells you to stop making minimum payments on your balance. Your lender will report non-payments to the credit bureaus, hurting your credit score.
You may pay high fees. When you agree to work with a debt settlement company, you may face an upfront fee, regardless of whether they successfully persuade your creditor to reduce your debt. They may also charge you a monthly maintenance fee and require you to deposit a lump sum into a savings account to cover the settlement. Together, these costs may be more than you can afford.
You receive no legal protection from creditors. A debt settlement company cannot prevent your creditor from seizing money from your paycheque or bank account. It also has no power to put a halt to collection calls. Only a consumer proposal arranged through a Licensed Insolvency Trustee can shield you from such creditor actions.
The negotiations can take a long time. There’s no precise date for the debt settlement company to contact your creditors – it’s up to their discretion. The longer they wait, the more your financial situation will worsen. Interest charges will continue collecting on your balance, and your credit will suffer as you miss payment deadlines.
Filing a consumer proposal to reduce the amount of debt you owe
A consumer proposal is a federal government program which can only be administered by a Licensed Insolvency Trustee. It’s the safest debt settlement option in Canada and offers unique advantages that other debt relief solutions don’t. At face value, it shares many similarities with private debt settlement. But there are several key differences.
A legally binding contract with your creditors
A consumer proposal is a legally binding agreement between you and your unsecured creditors. If the majority of your creditors agree to the terms of your proposal, they’re all bound by the agreement. At no point during the repayment process can any creditor opt out of the contract the way they can through a private debt settlement.
Zero upfront fees
When you file a consumer proposal, you start paying your creditors only after the agreement is filed with the government, never before. The administrative costs of your proposal are automatically built-in to your monthly payment.
Conversely, when you work with a debt settlement company, they take your money long before contacting your creditors. And they can collect from you for years before acting to address your debts.
Immediate stop to collection calls and creditor lawsuits
A consumer proposal provides instant relief from collection calls and legal action, such as wage garnishments. Once your proposal is filed and accepted with the Office of the Superintendent of Bankruptcy (OSB), the court will grant you a Stay of Proceedings, protecting you from legal threats and collection efforts by your creditors.
Unless the debt settlement company persuades your lenders to refrain from lawsuits and collection calls, they have no power to stop such actions.
A highly regulated debt relief program
Under a consumer proposal, your rights as a debtor are protected under the BIA. As a result, you’ll benefit far more from a legal perspective than you would if you work with a private company.
In Canada, only Licensed Insolvency Trustees can administer a consumer proposal. These debt management professionals are regulated by the BIA and must adhere to a strict Code of Ethics. They must undergo a rigorous training program and obtain relevant work experience before they can carry out consumer proposals (and bankruptcies) for individuals.
No interest charges to pay
Once creditors sign off on your proposal, the unsecured debts included, by law, will no longer accrue interest, saving you plenty of money.
This isn’t the case with a private debt settlement – interest charges will continue to amass on your outstanding balance from start to finish. The debt settlement company may attempt to waive or lower your interest rate. But your creditor is under no obligation to comply with the request.
Do non-profit credit counselling agencies offer debt settlement?
Credit counselling agencies can help you consolidate your unsecured debts and lower (or eliminate) the interest rate you pay. They do this through a debt management plan (DMP).
Enrolling in this program can help you save money and repay your debts sooner. A DMP typically lasts 36 to 60 months, during which you make fixed monthly payments.
Unfortunately, credit counsellors cannot legally provide debt settlement services, so you must still repay 100% of your principal. In contrast, a consumer proposal can wipe out up to 80% of your unsecured debts.
A DMP works best if you’re experiencing less severe financial hardship and owe relatively little unsecured debt. It’s particularly well-suited for credit card debt, given the high interest rates it charges.
Does debt settlement ruin your credit?
Debt settlement will hurt your credit score for some time. However, the extent of the damage will vary depending on which settlement solution you choose.
A private debt settlement you carry out on your own or with assistance from a private company will stay on your credit report for six years. A consumer proposal will remain on your credit report for three years after you complete your final payment or six years after your filing date, whichever comes first.
Final thoughts on debt settlement
Debt settlement can be an effective way to eliminate a significant portion of troublesome debts. But whether it works for you will depend on various factors. These include the total debt you owe, how much you can afford to repay, and your chosen settlement method.
Are you confident in your people skills and have only one or two small debts causing you grief? In that case, personally negotiating a settlement with your creditors is a feasible option. But remember that you’ll have no one to assist you if you encounter a roadblock. And you won’t be able to prevent your creditor from pursuing legal action against you to recover the debt.
Let’s say you hire a debt settlement company to help you strike a deal with your creditors. In that case, you’ll benefit from the expertise of professionals who can handle the bargaining process on your behalf. However, there’s no guarantee they’ll succeed in arranging a new debt agreement. Your creditors don’t have to agree to anything and can still chase you for payment while you work with the debt settlement company.
A consumer proposal is often the go-to debt settlement solution. It’s suitable when you owe a substantial amount of unsecured debt but still earn a steady income. Filing a proposal will grant you legal protection from creditors, waive your interest charges, and eliminate a significant chunk of what you owe.
Visit our consumer proposal page to learn how a consumer proposal works in practice and how it can help reduce the debt you owe.
Photo by ANTONI SHKRABA production