Debt Restructuring – Its Just Math
It’s Just Math: Should You Fear an Insolvency Filing?
As a Licensed Insolvency Trustee who has spoken to over a thousand people in the last 7 years of my professional career assisting individuals with debt problems, I have found that a lot of people fear the processes that are designed to help them. This leads me to ask a question to the people I meet with to understand where they are coming from, and why they are fearful of sometimes proceeding with a consumer proposal or bankruptcy:
“What is more important to you, having a good credit score or having money?”
The answer is always “money!”
At this point I would say, “money is one thing and credit is another, they are not the same.”
My job is help people understand the legal processes available to them to help them when they are overwhelmed by debt, or not yet overwhelmed, but simply have to much debt for any reason whatsoever, without any judgement.
There are two main reasons that people fear moving forward and we will discuss both through a case study of the average Canadian person.
The first is the effects on a person’s credit score:
Consumer proposals - Individual compromised (included in proposal) accounts will report on the credit report for a period of 3 years after the completion of the proposal, during the proposal at an R9, and after the proposal at an R7
Bankruptcy - Individual compromised (included in bankruptcy) accounts will report on the credit report for a period of the bankruptcy at an R9 rating, and for 6 years after completion of the bankruptcy at an R9 rating
This is the basic effect and the nitty gritty will be in my next Blog Post: “It’s Just Math: Effects of Insolvency Filings on Credit Score, Magical Computer Algorithms and How Your Credit Score is Calculated”
The second is access to credit:
In both bankruptcies and consumer proposals people can get credit/credit cards etc. while still in the process, they may pay more in interest, and credit limits will be lower. Legally, you are allowed to get credit as long as you are honest with the creditor about your situation and let them know if you have filed a bankruptcy/consumer proposal. It is not hard to get credit (look at how much credit you may already have, and you still get offers from banks all the time for more!), it is much harder to earn money. Each situation is looked at and all lenders treat things differently such as assets, income and previous history, so there are no guarantees on the type of credit, interest etc. you will get whether you are in bankruptcy, a consumer proposal or in in any situation where you are in debt either.
Now lets go through an example of what would happen if like many people I have helped over the years, you decide to let go of the fear and just go through a proposal to restructure your debts and overall finances:
In 2018 the average individual Canadian person’s employment income was $48,000/Year with an after tax net income of approx. $37,000 to $40,500 depending on which province you reside in. In the lowest taxing Province of Alberta this amounts to a $40,500/ year, which is earned over the course of one year at $3,375/ month.
Lets now assume that this person spends as follows:
35% to rent = $1181.25
10% on fixed costs living costs (utilities, cell phone, internet, tenant insurance etc.) = $337.50
12% on vehicle expenses (insurance, gas, maintenance, and repair costs) = $400
15% on variable household expenses (everything we would normally get at a grocery store) = $506.25
5% on entertainment and eating out = $168.75
7% on general living expenses (they buy clothes, household things etc.) = 236.25
5% on medical and health costs (gym memberships, OTC Drugs, Prescriptions etc.) = 168.75
That totals up to $2,998.75 so after all this is paid from the persons monthly income, they have $376.25 left. Now we have made some assumption’s here, this person does not have a child, not pet, no car loan, does not smoke/drink. This illustrates just one situation of one very average Canadian Person and when I help my clients figure out their budgets we go through there individual expenses to create a plan that works for them and every person will have different circumstances and therefore different expenses.
Now let’s say that this person has for whatever reason accumulated $20,000 in debt on a credit card and the interest is 20%. If that person dedicated 100% of there leftover funds of $376.25 to put towards payment of that one debt here is what happens:
It would now take this person 11 years of their life to pay this off, and in the process the accrued interest they paid totals at $29,418 (this occurs due to compound interest which is a whole other topic to be addressed in a later blog post). They have shelled out principal + interest of $49,418. At this point in time they would also have $0 net worth, they are just even with nothing saved.
Now remember this person is not just paying minimums nor do they have any other unforeseen circumstances ahead. This persons salary will not grow at 20% per annum to even match the growth of their debt, no average persons salary does that, but living expenses like rent, food, even taxes seem to grow at those rates at times.
So, it becomes a mathematical example of which would you rather have:
A Good Credit Score and no money for 11 years as out lined above, or a Lower Credit Score (that can be rebuilt fairly quickly), for a period of time and go through a consumer proposal as outlined below:
$150/month for 60 months for a total paid of $9,000
Which now leaves the person with a spare ($376.25-$150) $226.25 per month to put into savings for emergencies, put into an RRSP, put away for their children’s education or anything else. Let’s say they now do the following because they took my advice:
24 months of savings contributed at $226.25 = $5,430 is their emergency fund now built and ready after 2 years followed by;
36 months of savings contributed at $226.25/month = $8,145 is now a TFSA (tax free growth) that they invest into a Mutual Fund which earns a modest 5% interest.....Lets see what happens:
- After 5 years their proposal is paid off = no debt
- They have an emergency fund which can be used instead of credit when unforeseen circumstances occur
- They have future savings of $8,525
- They now have a positive net worth = they rebuilt their worth….literally! (It’s not just a slogan at Bromwich + Smith)
So as you can see it’s just math and there is not much to be fearful of.
There is also no cost to speak with a Licensed Insolvency Trustee like Bromwich+Smith to review your financial options, and simply going through your options does not effect your credit in any way, so I would say it’s always worth finding out if it makes financial sense to get your self on a plan to Rebuild Your Worth!