Your credit score is like a photograph. It’s a snapshot of your credit history at a certain point in time. When your credit is at its best, the photograph is flattering. When it’s not at its best, well, let’s just say those photos don’t end up on Instagram.
But many people think of their credit score as a tattoo – something that’s painful and arduous to remove once you’ve got it. People are afraid to negatively impact their credit, so they avoid doing things that could leave a permanent mark. This includes personal bankruptcy and consumer proposals: they’re tools for getting your finances, and your life, back on track, but people are reluctant to explore these options because of how they could affect their financial life afterwards.
Personal bankruptcy and insolvency do affect your credit score and ability to borrow money in the future. Yet the issue is more nuanced than you might expect – and filing for personal bankruptcy or a consumer report doesn’t mean that your financial future is doomed, or that the effect on your credit score is permanent.
In this blog, we’ll explore what kind of impact personal bankruptcy or consumer proposals will have on your financial future.
What’s the difference between personal bankruptcy and a consumer proposal?
First, let’s look at the difference between the two. According to a new report, 44 per cent of Albertans are only $200 away from insolvency. This means that it’s important to understand what might work for you and how your finances will be affected afterwards.
Personal bankruptcy is a formal process that relieves you of all your debts to creditors and allows you to retain certain assets. It provides protection against legal action or further collection by your creditors, giving you a clean financial slate. Personal bankruptcy is often the quickest debt restructuring plan to complete – it can be as fast as nine months. To declare personal bankruptcy, you need to be insolvent, which means you must owe at least $1,000, you must be unable to pay your debts and the value of all your assets must be less than what you owe.
A consumer proposal, on the other hand, allows you to negotiate a settlement to pay off your debt over a maximum of five years. Like personal bankruptcy, when you file a consumer proposal you’ll receive immediate protection against further action from unsecured creditors.
How do these options affect your purchasing and borrowing?
Personal bankruptcy or a consumer proposal will negatively affect your credit score. A consumer report will give you an R7 credit rating while bankruptcy will result in a R9 credit rating. (For perspective, an R1 rating means you pay your debts on time.) Consumer reports, therefore, are sometimes considered better than bankruptcy. Your consumer proposal will stay on your credit report for three years after completion. The quicker you pay it off, the sooner it will be gone from your credit report.
Still, a change in your credit score doesn’t mean your borrowing options are limited forever.
If you declare personal bankruptcy or file a consumer proposal, you won’t be able to use a normal credit card. However, you can still get a secured credit card, which will help you rebuild credit (although at a much slower pace than with a normal card). A secured credit card requires a small deposit, has higher fees and typically has a lower credit limit. (This isn’t the same as a pre-paid card, which won’t help you gradually rebuild credit.)
Although your loan terms will be different than if you haven’t gone through bankruptcy or a consumer proposal, many lenders could still approve you for a vehicle loan. Getting a vehicle loan and making monthly payments is actually one way to help rebuild your credit, and if you stay on top of your monthly payments you may be able to refinance later on at a lower interest rate.
It’s still possible to get a mortgage after bankruptcy or a consumer proposal, but you’ll have to rebuild your credit first. Your consumer proposal will stay on your credit report for three years after discharge. If you’ve filed for personal bankruptcy, Canada Mortgage and Housing Corp. will review your application as early as 18 months to two years after filing.
If you’re applying for a mortgage after a consumer proposal or bankruptcy, it’ll help to have a steady source of income and make a larger down payment – you’ll need at least 20 per cent. And remember: the longer you rebuild your credit for, the likelier you are of getting a mortgage at a more reasonable interest rate.
Tips for rebuilding credit
While changes to your credit score will certainly affect your ability to borrow money, these changes aren’t permanent. To find out how to start rebuilding your credit, stay tuned for part two of “Life after Debt”.