Debt Settlement in Canada: How Does it Work?

Opting for debt settlement can lower the total amount of money that you owe and help you get back on track with payments.

Dealing with crushing debt can feel overwhelming. You’re making payments, but the mountain barely seems to shrink. Bankruptcy might seem like the only way out, but there is another option: debt settlement.

Debt settlements can potentially reduce the total amount you need to pay back to creditors, easing the financial burden and helping you pay off debt faster. 

In this blog, we will explore the process of debt settlement in Canada, as well as its benefits and drawbacks.

Key Takeaways

• Debt settlement allows you to pay less than what you currently owe through a repayment plan between you and the lenders.
• You can negotiate this plan directly with creditors, seek assistance from debt settlement companies, or file a consumer proposal for a legal agreement.
• Debt settlement can negatively impact credit score, so you should carefully assess your financial situation and seek professional advice before pursuing a debt settlement.

What is a Debt Settlement?

Debt settlement is the process of negotiating with creditors to reduce the total amount of debt to be paid, often in the form of a lump sum payment or a series of smaller payments. If creditors agree, you can repay a portion of your debt instead of the full outstanding balance. 

Settling debts this way benefits both sides:

• For borrowers: You pay less overall and have lighter monthly payments.
• For creditors: They receive some payment, which is preferable to receiving nothing at all if you defaulted or declared bankruptcy.

How Debt Settlement Works in Canada

Debt settlement can either be informal (direct negotiations and debt settlement services) or formal (consumer proposal).

The first option is to negotiate directly with creditors. You can try reaching out to propose a reasonable settlement offer, considering the total amount you owe, your current financial situation, and what you can realistically afford to repay. 

If the thought of dealing with creditors stresses you out, you can seek assistance from debt settlement companies that specialize in the process. They will negotiate with creditors on your behalf and handle payments moving forward. Here’s how it works:

1. You contact a debt settlement company in Canada and discuss your specific situation. If you decide to proceed, you'll work with them to create a proposal.
2. Next, you stop making payments to your creditors and instead start depositing money into a dedicated bank account managed by the company.
3. The company uses the accumulated funds in your account to negotiate with your creditors. Their goal is to settle for a lower amount than what you owe (typically 30-70% of the original balance).
4. Once a settlement is agreed upon, the funds from your account are used to pay it off. The process is repeated for each lender until you clear all remaining debts.
5. Licensed Insolvency Trustees and debt settlement companies keep a portion of what you pay back, so it’s important to be aware of the additional fees being paid.

💡 As with any and all financial products or decisions, it’s crucial to do your research. Many debt settlement companies have financial incentives that may not be apparent, even if they are considered “non-profits”. The same can be said for Licensed Insolvency Trustees. Many of these organizations do not benefit from your financial rebuilding, only from selling you a specific debt program. Be wary, and always get a second opinion.

Another option is filing a consumer proposal. This is a formal process, so you’ll need to work with a Licensed Insolvency Trustee (LIT) to create a repayment plan. Both the debtor and the creditors are legally bound by the agreement once it’s accepted. You will make regular payments to the LIT who will then distribute the funds to creditors after they take their fees, which reduces your overall savings.

Consumer proposals, like bankruptcy, should be a last resort for debt relief due to the long-term consequences on your credit score and public record.

Advantages of Debt Settlement

• Significantly reduces your total debt
• Helps you avoid bankruptcy
• Makes your payment plan more manageable

Disadvantages of Debt Settlement

• No guarantee that creditors will accept your repayment plan
• Some debt settlement companies can charge high fees
• Has a negative, long-lasting impact on your credit score

Alternatives to Debt Settlement

Before moving forward with a debt settlement, it’s best to explore other debt relief options that may help you get out of debt faster or with less negative impacts.

Debt consolidation, for example, combines your debts into a single loan or credit line to simplify payment and reduce interest charges. 

If you’re still unsure, we recommend consulting with a financial professional to determine what would be the best option for your individual situation. Every situation is unique!

Frequently Asked Questions

What types of debt can be settled in Canada?

In Canada, debt settlement is only applicable for unsecured debt like credit card debt, payday loans, and bank loans. Secured debts like mortgages and car loans are not included.

Does debt settlement hurt your credit?

Yes, debt settlement can have a negative impact on your credit score especially if you hold off on making payments during negotiations. Additionally, a consumer proposal will remain on your credit report for at least 3 years after paying off all debts.

How long does debt settlement take in Canada?

The time frame can vary with the complexity of the debts involved. It may take several months to negotiate, depending on the cooperativeness of creditors, and a few more years to pay it off.

What should I consider when choosing a debt settlement company?

Check their reputation, accreditation, and track record of successful settlements. The Financial Consumer Agency of Canada warns against high fees and misleading claims by some companies in the debt settlement industry. To avoid this, compare rates to find the most reasonable fees and pay close attention to company policies before signing any agreements.

Conclusion

Debt settlement in Canada can offer relief to individuals struggling with a huge financial burden, and it can be a viable alternative for those considering bankruptcy in particular. But ultimately, the best way forward depends on your unique financial situation. There are several lower-impact debt relief alternatives that you can look into before making a decision.

Feeling overwhelmed by debt options? We understand, and we’re here to help. You can schedule a call with our Parachute financial coaches here or apply online to see if debt consolidation is right for you.