Consumer Proposal vs Debt Consolidation: Which One You Need

What is the main difference between debt consolidation and a consumer proposal and the benefits of each? In which financial situation would it be best to opt for debt consolidation services in Toronto over a consumer proposal and vice versa? And what these two definitions actually mean?

Let’s delve into the intricacies of the consumer proposal vs debt consolidation comparison so you can find the best debt management and solve your debts for good.

The Difference Between Debt Consolidation and Consumer Proposal

Debt consolidation and consumer proposal are two words that you may hear rather often when talking about debt settlement, but they are not the same thing.

The main difference between the two is that debt consolidation loans typically combine all of your debts under a single payment – and usually under lower interest rates, whereas consumer proposals, in addition to consolidating debt, also reduce your total debt balance and entail no interest charges.

That was us briefly mentioning the key differences between consumer proposal vs debt consolidation loans. Now, let’s dig a bit deeper and understand what debt consolidation loan is, how it works, what pros and cons it brings to the table compared to consumer proposals, and when it’s best to use one.

What Is Debt Consolidation Loan?

A debt consolidation loan is a financial strategy where multiple debts are combined into a single loan with a lower interest rate, typically resulting in a lower overall monthly payment. This loan is used to pay off existing debts, such as credit card balances, personal loans, or medical bills, leaving the borrower with just one monthly payment to manage.

How Does Debt Consolidation Work?

When you opt for a debt consolidation loan, you apply for a new loan, ideally with a lower interest rate than the average rate of your existing debts. Once approved, you use the funds from the new loan to pay off your existing debts in full. This leaves you with a single loan to repay, simplifying your financial obligations.

Pros of Debt Consolidation:

  • Managing multiple debts can be overwhelming and confusing, but with a consolidation loan, you only have one monthly payment to keep track of, which makes the life of borrowers easier.
  • By securing a consolidation loan with a lower interest rate, you may save money down the line, especially if your existing debts carry high-interest rates.
  • As you pay off your existing debts in full, your credit utilization ratio may improve, positively impacting your credit score.
  • Consolidation loans often come with a fixed repayment schedule, making it easier to budget and pay back the debt.

Cons of Debt Consolidation:

  • Qualifying for a consolidation loan may require a good credit score and a stable income, which some individuals may be struggling to prove.
  • Some lenders may charge origination fees or other upfront costs associated with obtaining a consolidation loan.
  • Clearing existing debts with the bank might create the temptation to accumulate new debts if spending habits aren’t addressed.
  • Unlike consumer proposals, debt consolidation does not reduce the total amount owed. It simply reorganizes the original debt into a more manageable structure that you can afford to pay off.

When Is Debt Consolidation Ideal?

Debt consolidation is ideal for individuals who have multiple, high interest loans and are looking for a streamlined debt management plan. It can be particularly beneficial for those with good credit scores and a stable income who can qualify for favourable loan terms.

However, if you’re struggling with overwhelming debt and are unable to keep up with monthly payments even with lower interest rates, a consumer proposal might be a more suitable solution. Additionally, if you’re facing legal actions from creditors or your debts are unmanageable even with consolidation, seeking advice from debt relief experts is recommended.

What Is Consumer Proposal?

A consumer proposal is a formal debt settlement arrangement governed by the Bankruptcy and Insolvency Act (BIA) in Canada. This is a legal agreement, also known as a form of debt forgiveness, that allows borrowers to negotiate with creditors and pay off only a portion of their debt instead of paying the entire amount as in the case of debt consolidation.

Typically, the term over which the debt can be paid off is up to five years. A consumer proposal combines most unsecured debts, such as medical bills, personal loans, tax debts, and so on, but not payment loans like mortgage, car loans, and other similar expenses.

How Does Consumer Proposal Work?

When you file a consumer proposal, you work with a Licensed Insolvency Trustee (LIT) or credit counsellor to create a proposal detailing how much you can afford to pay back to your creditors.

This proposal is then sent to your creditors for review and voting. If the majority of your creditors accept the proposal, it becomes legally binding on all parties involved.

This is the main advantage of consumer proposals over debt consolidation loan, as it should be way easier to secure a consolidated loan with the help of a Trustee. Other pros of consumer proposal are listed below.

Pros of Consumer Proposal

  • A consumer proposal is interest-free. You will repay your debt without interest payments, unlike debt consolidation. With consolidation, you will take an additional consolidation loan that will continue to run interest.
  • A consumer proposal deals with all your outstanding debts and allows you to pay a lower amount than you owe your creditors.
  • You can attain a low monthly repayment with consumer credit. In addition, there are no collateral needs, and you do not risk losing your assets as is the case with a secured debt consolidation loan.
  • A consumer proposal is effective in stopping all collection action and prevent all forms of wage garnishments. With a consumer proposal, you can repay the debt in a quicker period with no penalties.

Cons of Consumer Proposal

  • A consumer proposal will negatively impact your credit score and remain on your credit report for several years, making it challenging to obtain credit in the future.
  • Consumer proposals are a matter of public record, which means they can be accessed by anyone who searches your credit history.
  • Depending on the terms negotiated in the proposal, you may be required to surrender certain assets to the trustee for liquidation to repay creditors.
  • Not everyone qualifies for a consumer proposal. You must meet specific eligibility criteria, including having a certain amount of debt and being insolvent.

When Is a Consumer Proposal Ideal?

A consumer proposal is ideal for individuals who are struggling with overwhelming debt and cannot afford to repay their debts in full. It’s suitable for those facing legal actions from creditors or those whose debts are unmanageable even with debt consolidation.

If you’re looking for a solution to reduce your total debt burden and need protection from creditors, a consumer proposal may be the right option for you. However, it’s essential to consult with a credit counsellor to assess your financial situation and explore all available debt relief options to get the legal protection you need.

How Badly Does a Consumer Proposal Affect Your Credit?

A consumer proposal can have a significant impact on your credit score and financial standing. Since it involves negotiating with creditors to pay back only a portion of your debt, it signals to future lenders that you have struggled with debt management in the past. As a result, your credit rating will likely decrease, making it more challenging to obtain credit in the future.

Additionally, a consumer proposal remains on your credit report for several years, typically up to seven years from the date of completion. During this time, potential creditors, landlords, or employers who conduct a credit check will see the consumer proposal on your record, which may affect their decisions.

Furthermore, since consumer proposals are a matter of public record, they can be accessed by anyone who searches your credit history, potentially impacting your reputation and credibility. For those planning to start a business or take out a mortgage, having a consumer proposal on your credit report can present hurdles.

So, it’s important to consider these consequences carefully before pursuing a consumer proposal. While it can provide relief from overwhelming debt on a short term scale, the long-term effects on your creditworthiness and financial stability may not be worth it.

Working closely with a credit counsellor or financial advisor can help you understand the implications and explore alternative solutions to manage your debt effectively.

How to Get Approved for Debt Consolidation?

If you’re considering debt consolidation or a consumer proposal, it’s crucial to understand your options fully and choose the one that best fits your financial situation and goals. Debt consolidation can simplify your payments and potentially save you money on interest, while a consumer proposal can provide debt relief and protection from creditors. However, both options have their pros and cons, so it’s essential to weigh them carefully.

Some Steps to Increase Your Chances of Approval:

  • 1. Check your credit rating: Before applying for a consolidation loan, review your credit report to ensure its accuracy. A higher credit rating improves your chances of qualifying for better loan terms.
  • 2. Improve your credit Score: If your credit score is lower than desired, take steps to improve it by making timely credit payments, reducing credit card balances, and correcting any errors on your credit report.
  • 3. Evaluate your debt-to-income ratio: Lenders assess your ability to repay the loan by analyzing your debt-to-income ratio. Lowering your debt-to-income ratio by paying down existing debts or increasing your income can strengthen your application.
  • 4. Gather necessary documentation: Prepare necessary documents, including proof of income, employment history, and details of existing debts, to streamline the application process.
  • 5. Compare lenders: Research and compare various lenders offering debt consolidation loans, considering factors such as interest rates, fees, and repayment terms. Choose a reputable lender that offers favourable terms based on your situation.
  • 6. Apply for pre-approval: Some lenders offer pre-approval, allowing you to assess potential loan terms without impacting your credit score. Pre-approval gives you a clearer picture of your borrowing capacity and helps you narrow down your options.
  • 7. Submit a comprehensive application: Complete the loan application accurately and truthfully, providing all requested information. A well-prepared application demonstrates your seriousness and increases your chances of approval.
  • 8. Consider a co-signer: If you have a limited credit history or poor credit score, consider applying for the loan with a co-signer (Licensed Insolvency Trustee) who has a stronger financial profile. A co-signer can improve your chances of approval and may help secure more favourable loan terms.
  • 9. Be Prepared for Possible Rejection: Despite your efforts, there’s a possibility of rejection. If your application is denied, don’t lose hope. Take steps to address any deficiencies identified by the lender, such as improving your credit score or reducing your outstanding debt, and consider alternative debt relief options.
  • Contact Us to Live a Debt-Free Life

    If you’re unsure which option is right for you, or if you simply need guidance on managing your debt, we’re here to help. Contact us today for a free consultation with one of our experienced debt relief experts. Together, we can explore your options and create a customized plan to help you become debt-free.