If you were to lose your job today, do you have enough funds to live off of for a few months before you found a new job? For many people the answer is no. This is where I feel emergency funds are very important (at least for us). I know we’d be stressed…
For most individuals any long-term drop in take-home pay makes them vulnerable to financial difficulties that could lead to bankruptcy. The numbers tell this tale. A recent study in Canada told us that Prince Edward Island had the biggest rise in bankruptcies of any province in Canada so far this year, according to numbers just released by the federal government. “Bankruptcies and consumer proposals in 2014 are up 14 per cent over this time last year.” In the United States, a total of 1,107,699 bankruptcies were filed in 2013. Those are some scary statistics.
Regardless of which country you live in the decision to file for bankruptcy is not an easy one and I think this decision has implications. Before making that decision, consider the following below.
Know Your Options in Canada
In Canada, The Bankruptcy and Insolvency Act (BIA) is the federal statute which governs bankruptcy and insolvency and applies to all provinces and territories. In addition to their jurisdictions, each province has its own rules and regulations pertaining to the situation.
Before you move down the path of bankruptcy, there are two types of debt management strategies to consider. The first being a Consumer Proposal and the other the Division 1 Proposal. So which solution is best for you?
With the Consumer Proposal option you can work with your creditors through a licensed bankruptcy trustee. A legal agreement is negotiated between the two parties, protecting you from debt collectors while setting up a partial repayment of your debts. To qualify, your total debt must be less than $250,000, excluding mortgages. It is also important to note that even if you file a consumer proposal, it is not guaranteed to be granted. Your creditors will have to agree with the arrangement, and if they do, fixed monthly payments will be negotiated. If the consumer proposal is denied, personal bankruptcy might be your best option; more on that shortly.
With the Division 1 Proposal option anyone (individuals and businesses) who owes more than $250,000 can apply. Like the consumer proposal, this proposal allows you to negotiate with your creditors to reach a settlement for paying off your debt. If the division 1 proposal is not accepted, there will be no other alternatives, leading to automatic bankruptcy.
If neither proposal is available to you, and you’ve explored other options (i.e., a debt consolidation loan or a debt management plan), filing for personal bankruptcy is likely the last stop. There are obviously implications to declaring bankruptcy and you should be aware those, namely, not all your debts will be erased when you file.
Bankruptcy only dissolves unsecured debts, such as credit cards, personal loans, overdrafts, etc. It is important to note though that not all unsecured debt will be expunged. Student loans, alimony, and child support will continue to be a part of your financial obligations. Secured debts, assets which can be used as collateral (home mortgages, car loans, or a lien) are exempt from the bankruptcy. Because bankruptcy does not wipe away secured debts, as long as you keep up with your payments, you will be able to keep your home and car. Failure to pay, or if you fall behind in your payments, can lead to foreclosure.
Some serious questions to ask yourself before filing for bankruptcy:
- How will bankruptcy benefit you if you file?
- Will you be able to pay off your debt within the next five years?
- Can you secure some stable income at some point?
Navigating the United States Bankruptcy Process
In the States, The United States Code controls the bankruptcy process, which is broken down into titles, which include within each title, chapters. The three most common types of bankruptcy in the United States are Liquidation (Chapter 7), Reorganization (Chapter 11), and Individual Debt Adjustment (Chapter 13).
If you have little to no disposable income Liquidation Bankruptcy is probably your best option. Under this Chapter, you move into a liquidation bankruptcy where your assets are sold in order to pay off your credit cards and other bills. Because Chapter 7 is for low income individuals, there are usually very few assets to sell, but this option provides the debtor a quick discharge from most of their debts and gives them a fresh start.
Reorganization Bankruptcy or better known as Chapter 11 is used when a business or partnership is unable to meet their financial obligations while reorganizing a business, working to keep it open, and paying off creditors over time.
In most cases Chapter 13, the Individual Debt Adjustment Bankruptcy, is the bankruptcy option most people qualify for. Similar to Canada’s consumer proposal Chapter 13 allows individuals to work with their creditors to pay off their debt, stop the collection calls, and keep their assets.
In closing there are distinctions between bankruptcies in Canada versus the United States but neither protocol is ideal – far from it. Bankruptcies are real, they could happen and they do happen when not enough financial risks are mitigated.
In Canada very few personal bankruptcies occur due to over-leveraged real estate. We did a detailed analysis of all of the people who filed bankruptcy with my firm (results are at http://www.joedebtor.ca ) and divorce is a significant factor, as is job loss. The most recent government of Canada statistics show that about 118,000 individuals filed bankruptcy or a consumer proposal in the last year, which is down substantially from the peak of around 150,000 during 2009 as a result of the credit crisis and recession.
Thanks for your comments Doug and sharing your link. Some small comment however, just as they say in the investment industry, past performance is not indicative of future results. In this regard, although a small portion of personal bankruptcies occur due to over-leveraged real estate this does not mean it cannot occur.
On the more/slightly positive side, there are more consumer proposals now:
Hi Mark; yes, I agree, bankruptcies caused by over-leveraged real estate do occur, and if interest rates increase that will become a much more significant cause of financial difficulty, particularly for those with variable rate mortgages.
For sure Doug. On the positive side, the folks with variable rate mortgages are getting one heckuva deal right now with these prolonged, low rates.
The harsh reality is that bankruptcies are still incredibly high in the U.S. and it doesn’t seem like a respite is coming any time in the near future. On a bright note, after going through a bankruptcy process you are afforded a fresh start and in time credit scores do rebuild. I think people place too much emphasis on credit scores and forget that the numbers are dynamic not static. They change with the ebbs and flows of every persons’ financial situation and one shouldn’t worry too much about a low credit score after bankruptcy as long as going forward they are responsible and rebuild their damaged credit.
Yes, the rate is high but at least folks have a pathway to start over. People deserve this chance and it seems both systems in Canada and the U.S. support that. Thanks for the comment DivHut.
Nice article, talking about an oft-ignored topic on personal finance blogs. Although it may not happen for people like us, it’s a potential reality for many of our friends, family, and coworkers. Sometimes it’s their fault, sometimes not. The most important thing is that you prevent being in that kind of situation as much as possible with investments and savings, and if you ever are in bankruptcy, get out and on a sound financial footing ASAP. Bankruptcy should only ever be a last resort.
Unfortunately, it is a reality for many people DividendDeveloper…I hope I’m never ‘there’.
Interesting topic and hopefully one not many people have to deal with in their lives. I didn’t know that about the student loans, both in the article and the 7 year thing that Brian mentioned above
Same, re: student loan discharge. I decided to pay mine back 😉
It’s always sad to hear someone declares bankruptcy. Like Daisy, I doubt I’ll ever in this position. 🙂
Agreed, this would be very tough.
It makes me sad that anyone would feel helpless enough to the point where they would have to declare bankruptcy – thankfully I have never been there and I doubt I will ever be in that position but it’s a good thing it is an option.
Same Daisy, but it happens.
Nice change of pace article. I think most people underestimate the rate of bankruptcies in both Canada and the US, so they don’t ever think it will happen to them.
One thing to note is that student loans over 7 years from when you were a full time student can still be discharged, so not all student loans are ineligible.
Thanks Brian, I appreciate your take on my posts. Good to know about student loans, I didn’t know that.