Debt Consolidation vs Bankruptcy in Canada

If you’re feeling overwhelmed by debt, you’ve likely come across options like debt consolidation and bankruptcy when doing some initial online research. While both can provide relief, they’re very different paths, and understanding the pros and cons of each can help you decide which is best for your unique situation.

At a glance, debt consolidation simplifies your debt by combining multiple debts into one loan, potentially lowering your interest rates. Bankruptcy, on the other hand, offers a more drastic solution by legally discharging some or all of your debts – but comes with a significant impact on your credit and possibly your assets.

In this guide, we’ll explain the key differences between debt consolidation and bankruptcy – helping you make an informed decision about the next steps you might want to take.

Debt Consolidation vs Bankruptcy: How Do They Compare?

Debt consolidation and bankruptcy are both designed to help you manage debt, but they differ significantly in how they work, their impact on your finances, and the long-term consequences.

In this comparison, we’ll cover:

• How each option works
• Eligibility requirements
• Impact on your debt and credit
• How payments are handled
• Effect on your assets
• Costs and fees
• Flexibility and risks

By the end of this guide, you’ll have a clearer understanding of how each option could fit your financial needs.

What Are Debt Consolidation and Bankruptcy, and How Do They Work?

Debt Consolidation

When people “consolidate debt,” they will take a large new loan to pay off multiple existing debts, leaving just one monthly payment.

Although usually a personal loan, some people opt to get a balance transfer credit card – usually if their existing debt is spread across credit cards. In some cases, people will take a home equity loan and use that to clear existing debts.

Gathering all your debt payments together can make it easier to manage your finances and, if you secure a lower interest rate, could save you money in the long run. However, consolidating debt doesn’t reduce the amount you owe—it just restructures it.

Bankruptcy

Bankruptcy is a legal process designed to provide relief from overwhelming debt when you can’t pay it back. There are two main types of bankruptcy for individuals in Canada: Chapter 7 bankruptcy (discharge of most debts) and Chapter 13 bankruptcy (restructured repayment plan).

Bankruptcy can erase your debts or significantly reduce them, but it comes with significant consequences for your credit and can impact your assets.

Eligibility and Qualification

Debt Consolidation

To qualify for a debt consolidation loan, lenders will assess your credit score, income, and overall financial health. You’ll need a decent credit score to secure a low interest rate.

If your credit is poor, you might still be approved, but the interest rates could be high, which can sometimes make debt consolidation programs less effective.

If you decide to go down the home equity line, your credit health will still be considered – although the security in your home will often be enough for lenders to feel they can lend to you with a fairly low risk. While this might seem like the obvious option, it’s important that people carefully calculate the costs associated with this. Mortgages and secured loans with your house as collateral may end up being repaid over a long period – adding significant interest.

Bankruptcy

Bankruptcy doesn’t have strict credit score requirements since it’s meant for those who are insolvent – meaning they can’t meet their debt obligations.

If you decide bankruptcy is right for you, you’ll need to show that you’re unable to pay back your debts. Each type of bankruptcy has different eligibility criteria, with Chapter 13 requiring some regular income to make payments under a court-supervised repayment plan.

Impact on Debt and Credit

Debt Consolidation

With debt consolidation, you’re still responsible for repaying the full amount of your debt, but you benefit from potentially lower interest rates and simplified payments.

If you consistently make payments, your credit score may improve over time as you reduce the overall amount you owe.

Bankruptcy

Bankruptcy, particularly Chapter 7, can eliminate much of your unsecured debt (credit cards, personal loans, etc.), but it delivers a severe hit to your credit.

A bankruptcy filing stays on your credit report for six years (for Chapter 13) or up to seven years (for Chapter 7) in Canada, making it difficult to obtain credit, rent housing, or secure certain jobs during that time.

Payment Structure

Debt Consolidation

Once you take out a debt consolidation loan, you make a single monthly payment to repay it, usually at a fixed interest rate.

This can be helpful if you’re dealing with multiple creditors and want to simplify your finances. However, you’ll need to ensure the payments are manageable and the loan term is reasonable to avoid paying too much in interest over time.

Bankruptcy

In Chapter 7 bankruptcy, you typically don’t make any further payments on your discharged debts, but you may have to surrender some assets.

Chapter 13 bankruptcy involves a court-approved repayment plan, where you pay back a portion of your debts over a period of three to five years.

Impact on Assets

Debt Consolidation

A debt consolidation program doesn’t directly affect your assets since it’s primarily focused on restructuring your existing debt. However, if you take out a secured consolidation loan (using your home or car as collateral), you risk losing the asset if you can’t make the payments.

Bankruptcy

In bankruptcy, your assets could be affected. Under Chapter 7, you may be required to sell certain non-exempt assets (like a second car or expensive jewellery) to pay creditors – although this isn’t always required.

Chapter 13 allows you to keep your assets, but you’ll need to follow a repayment plan. However, some essential assets like your primary residence and vehicle may be protected depending on your province’s bankruptcy exemptions.

Costs and Fees of Debt Consolidation and Bankruptcy

Debt Consolidation

The costs of debt consolidation primarily come from the interest you pay on the loan. Some lenders might charge additional fees like loan origination or administration fees, but these are usually minor compared to the long-term interest costs.

Bankruptcy

There are court filing fees and trustee fees associated with filing for bankruptcy, as well as costs for mandatory credit counselling sessions.

These costs vary depending on the type of bankruptcy, but overall, bankruptcy tends to be more expensive upfront than debt consolidation, though it may eliminate a larger portion of your debt.

Flexibility and Risk

Debt Consolidation

Debt consolidation offers flexibility in how you manage your debt. If you secure a favourable interest rate, it can make repaying your debt more affordable, but it doesn’t solve underlying financial problems.

If you continue to build up debt without changing your habits, you could end up in a worse situation further down the line – especially if you keep the credit cards you pay off and find yourself using them again – effectively doubling your debt.

Bankruptcy

Bankruptcy provides legal protection from creditors, stopping wage garnishments and collection actions. However, it’s less flexible than debt consolidation and has long-term consequences for your credit and financial standing.

Bankruptcy is generally considered a last resort because of its impact on future borrowing and your reputation.

Bankruptcy vs Debt Consolidation Loans: A Summary

Debt consolidation and bankruptcy both offer paths to debt relief, but they serve very different purposes.

Debt consolidation works best for those who have good enough credit to qualify for a loan with a lower interest rate, but it doesn’t reduce the total amount you owe.

On the other hand, bankruptcy is a more drastic solution for those who cannot meet their debt obligations. It provides relief by discharging debts, but it severely impacts your credit and may involve losing some assets.

Choosing between these options depends on your financial situation, your ability to make future payments, and the long-term impact you’re willing to accept. To decide which is right for you, you should consider speaking with a licensed insolvency trustee or a financial advisor who can assess your unique financial situation.