Here's an interesting way to re-establish your credit. Ask your banker that you'd like to buy a $5000 five year Guaranteed Investment Certificate (or GIC). Your banker will say fine, let's see your $5000. Well, you'll explain, you really don't have $5000, but can you borrow it from his bank? Because this is a 'secured' loan - the bank has a piece of paper saying you owe them $5000 which is offset by another piece of paper saying you now have $5000 on deposit - chances are pretty good that you'll be approved. Now all you have to do is ensure a payment is made to the bank each month, without fail. Both the loan and the record of your payments will be reported on the credit bureau and, if you're paying the full payment on time each month, your credit bureau history will soon start looking pretty good. As an added bonus, you will have managed to save $5000!

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Debtor Options:

Avoiding your Debt
Debt Arbitration/Debt Settlement
Consolidation
Debt/Credit Counselling
Bankruptcy

Option 1: Avoiding your Debt

While doing nothing is an option, it’s not a particularly good one. People who find themselves at this point have reached a kind of ‘paralysis.’ They are afraid – of the debt, the collection calls and what unknown consequences they’re facing – and they're overwhelmed. They don’t have a solution, and don’t know where to turn for one.

Then there are those who have convinced themselves that if only they can keep making the minimum or even partial monthly payments they can somehow manage. In fact they can’t, but in struggling to try they will compromise on everything else in their lives: food, heat, family occasions and so forth. They have resigned themselves to a bleak and hopeless future of financial despair, devastation, desperation and deprivation.

If payments to the creditors simply stop, that person’s credit history is being destroyed and none of the debt is being paid off.

If minimum payments are being made each month, it will still take several decades – yes, decades – to eliminate today’s typical unsecured debt load.

Option 2: Debt Arbitration/Debt Settlement:

Debt settlement – also known as Debt Arbitration - is a process used by both people in debt and their creditors to negotiate mutually acceptable settlements of existing debts. It is an effective and popular way of quickly eliminating unsecured debt.

Independent Debt Arbitrators negotiate lump sum settlements with creditors on behalf of a debtor. The debts are paid off in anywhere from a few days to a year with most settlements completed within 30-60 days. Debt Arbitration typically negotiates the amount to be paid down to between 20% and 50% of the current balances.

Debt settlement is an alternative to bankruptcy. Unlike a bankruptcy rating recorded on an individual’s credit history, resolution of the debt is simply recorded as ‘Settled’ and with a zero balance. Another difference is that the arbitrator is solely the debtor’s advocate and puts himself between the debtor and the creditor. The collection calls and letters will stop and the creditor or representative – usually a collection agency – will deal directly with the arbitrator rather than the debtor. Other differences are that Debt Arbitrators can negotiate with creditors – bankruptcy trustees cannot -, and Debt Arbitrators are under no obligation to disclose anything about a debtor to his/her creditors while trustees are. Precisely because of these restrictions on bankruptcy trustees, quite often they will find it in their client’s best interests to refer him or her to a debt arbitrator to negotiate a settlement.

The one critical factor is the debtor’s availability to cash. It’s all well and good to negotiate a settlement, but at the end whatever amount has been agreed to needs to be paid almost immediately. This money may come from family, friends, the sale of an asset or a loan. It is best for the debtor to have funds on hand prior to the start of negotiations. The alternative is to acquire or otherwise accumulate the money over a period of time. As a rule of thumb, clients should have access to cash equivalent to 50% of the debt. This would also cover our fee. Almost all settlements together with fee come in at less than 50%, but it’s always best to have a cushion.

Option 3: Consolidation/A Consolidation Loan

Debt consolidation is a loan, paying out your unsecured debts and securing the new loan with your most valuable asset, in most cases your home equity. Occasionally a lender will combine your various debts into one large unsecured loan, but it’s rare and it depends on a number of factors: your debt-to-income ratio, your payment history, your relationship with the lender and so forth. You still need to qualify, and there can be a lot of variables. In many cases, the debt-to-income ratio is too high, or bad credit will not allow approval of an unsecured debt consolidation loan or will determine a higher interest rate even if it is a secured loan.

Consumers considering debt consolidation are looking for four things: cash flow relief (the current payments being too high), combining all the debts into one loan, a reduced interest rate (unsecured debt typically carries a much higher interest rate than secured debt), and lower payments. A good consolidation loan will deliver all this. But keep in mind that the creditor gains too. Unsecured debt has been swapped for secured: if you miss payments on the loan, you stand to jeopardize your security: in many cases it is your most valuable asset…your home. And there are often additional costs – especially if real estate is involved – which the lender will be happy to add onto your new loan.

So the question is, will your bank or credit union consolidate all your high interest unsecured debt? Well, that depends.

If your credit history is satisfactory and your creditor payments are current, your income is good, and your debt-to-income ratio is within range, there’s a pretty good chance you’ll get that consolidation loan. Your lender will almost always insist that the loan be secured by something of value you own: a vehicle if not more than three years old and clear title, or equity in your house if you happen to be a homeowner.

For those who are successful at getting their unsecured debt consolidated, they’ve taken an important first step in getting their situation under control and ultimately eliminating their debt. Then, almost invariably, they fail to take the next step which is just as important: they keep instead of destroy their now zero-balance credit cards and keep open instead of close their now zero-balance unsecured lines of credit and overdrafts at the bank or credit union. Human nature being what it is, the temptation at some point to fall back on the cards, the lines of credit or the overdraft all too frequently sees the debtor(s) putting his/her/their future in jeopardy. Having traded unsecured debt for secured (the family car or house, as examples), the odds are 2 to 1 that those zero-balance cards and accounts will be maxed out in within two years as they begin adding on new unsecured debt. Not only has the debt load become heavier than ever, with both secured and newly acquired unsecured debt to pay off, but the family assets are now in direct danger.

The absolute Number 1 requirement for consolidation loans to succeed is personal discipline. If you use (the cards, lines of credit, and overdrafts), you lose.

But what about those whose credit history is not considered satisfactory, or income is too low or non-existent and whose debt-to-income ratio is right off the road? And what if there are no assets to put up as collateral? And what if there is no co-signer to guarantee the loan, as lenders dealing with clients with the above problems like to insist on? Well, those applicants are not going to get their consolidation. It’s just that simple.

Option 4: Debt/Credit Counselling (or Debt/Credit Management):

Debt Counselling Programs (or Credit Counselling or Debt/Credit Management Programs, as they’re sometimes known as) are for those who need to get their unsecured debt problems under control but can’t qualify for a consolidation.

There are lots of them out there - for-profit and not-for-profit, high fee and low.

The essential idea behind them is that in exchange for paying off your debts via a single monthly payment within a specific period of time (five years is about the maximum, and depending on the amount of debt and the amount of the monthly payment may be less than five years), the creditors will halt collection or legal action and give you a break on the interest. That’s a big concession, because interest is such a large part of the minimum monthly payment. In reducing the interest, your monthly payment through the counselling firm, less their fee, is being applied almost entirely to actual debt reduction. It is much like a low-interest loan.

Debt counselling programs initially came about with assistance from creditors in order to recover debts from struggling consumers. Provincial governments as well operated similar programs such as Orderly Payment of Debts (or OPD). Today, OPD programs have been largely phased out. Debt counselling is pretty much a privately run for-profit industry. There are a number of non-profit firms operating as well.

There is some downside to these programs.

It’s important to remember that any creditors' participation in these programs is entirely at their discretion and on their terms. And not all creditors agree to participate. Counselling programs therefore only really exist at the pleasure of creditors and should be properly viewed, however indirectly, as funded, sponsored or otherwise subsidized by them. Some services rely on direct creditor funding. Either way, the creditors are paying these organizations to collect payments for them.

Now there’s nothing inherently wrong with being funded, sponsored or subsidized by creditors. The real question for the consumer is how much of the benefit sticks to the counselling program and how much of it translates into real assistance for the consumer.

These services are not free. They all charge fees, which again is fine, but the consumer should be aware that the range of these fees can be quite broad. So it’s important for the consumer to determine up front what the total cost of the program is going to be. Some charge an initial fee plus ‘set-up’ fees per creditor, and all charge a monthly fee on each payment made. And don’t assume that just because a firm advertises itself as ‘non-profit’ that somehow that translates into ‘lower fee.’ A lot of us are drawn to the term ‘non-profit’ because it strikes just that chord – ‘no fees,’ ‘lower fees’ or ‘low cost.’ Non-profits can charge as much or more than a ‘for-profit.’

It’s important, too, to remember that many non-profits are in fact directly and substantially funded by creditors whereas most for-profits are not. One consequence of this is that a consumer may discover that the for-profits have negotiated better benefits from creditors for clients than the non-profits have.

Creditor-funded counselling programs are really not unlike how collection agencies are paid by creditors, but with you, the consumer, paying fees on top of it.

The interest breaks you can get on these programs, like the fees, can vary widely. As said, some firms, particularly the non-profits, are either wholly or in part directly funded by the credit industry. So in shopping around, a good question to ask ‘XYZ Credit Counselling Ltd.’ is whether in fact it is being funded by creditors. Another question to ask is if ‘ABC Bank’ is offering to reduce its interest to zero through a non-subsidized firm, is it offering the same deal through a firm it is subsidizing?

Those on a counselling program will have a ‘7’ placed on their credit bureau history beside each creditor on the program. People frequently get upset at this, thinking their credit is somehow ruined. It’s not. A 7 is neutral and should not be regarded as either positive or negative. All it means is that the debtor has sought assistance in managing his/her financial affairs. It’s also insurance for the creditors who have agreed to provide the assistance: the 7 ensures that the debtor does not obtain more unsecured debt until he/she has completed the program and becomes debt free. That’s all on the good side. The bad side is that the 7 stays on the credit history for – at last report – some three years after the end of the program. So if a debtor stays on the counselling program a full five years, it will be eight years before the 7 rating falls off his/her credit history: that’s a longer period of time than if he/she had simply gone bankrupt. The other thing about this rating is that once the debts have been paid off and the now former debtor wants to apply for credit again, there may be a higher interest rate attached to that new loan or credit card because of it.

Despite their shortcomings and perceived conflicts-of-interest, debt/credit counselling programs remain an alternative for those who can’t get a consolidation loan, don’t qualify for bankruptcy and aren’t in a position to pursue settlements. The key here is ‘buyer beware,’ so it’s important to shop around.

Option 5: Bankruptcy:

Being bankrupt means you no longer have the ability to meet your financial obligations. The bankruptcy process is a legal way for those in an impossible financial situation to start fresh. Therefore bankruptcy is a perfectly viable option for many. Many consumers view bankruptcy as the most expedient way of resolving financial difficulties. However, bankruptcy remains a last resort rather than a first choice.

A record of your bankruptcy forms a part of your credit bureau history for years, while many credit applications ask if you’ve been bankrupt. It doesn’t necessarily mean you won’t get credit after you’ve been discharged, but it does mean that getting new credit will now become more difficult and frequently more expensive. There are certain jobs and positions that require you to disclose whether you’ve been bankrupt. Remember, bankruptcy is in fact a matter of public record and publication, and is not just restricted to a notation on your credit bureau history.

As a general rule of thumb, the cost to the individual assigning into bankruptcy is about $1000. Most but perhaps not all of your debts will be discharged: certain debts are specifically excluded from bankruptcy. On the other hand, there are assets which are excluded from bankruptcy proceedings. These exemptions are different from jurisdiction to jurisdiction (ie: each province is considered a separate jurisdiction).

To find out more about bankruptcy and whether it may be in your best interests to assign into bankruptcy, the best advice is to telephone any trustee found in your local Yellow Pages. Most if not all will provide you with an initial free interview.