If you are struggling with high interest credit card debt or balancing multiple loan payments every month you may be looking for a way to consolidate your debt into your home mortgage, a second mortgage or a home equity loan. This assumes that the equity in your home is greater than what you owe. But you need to ask yourself, is this the best option or are there other options that are better? Before going to your bank, mortgage broker or a credit counsellor, you should consider seeing a Licensed Insolvency Trustee (“LIT”) to talk about a consumer proposal.
A consumer proposal is a way to combine your unsecured debts into one lower monthly payment and may allow you to get out of debt sooner. Yes, even when you are paying your debts in full plus the fees of the LIT. And you are not subject to any qualifying criteria or interest rate fluctuations. So, when does it make sense to either file a consumer proposal or refinance the equity in your home.
Home Equity or Debt Consolidation Loan
Homeowners can consolidate credit card debt, lines of credit and other personal loans into their mortgage either by refinancing or by taking out a home equity loan or a second mortgage. A debt consolidation loan secured by the equity in your home will usually carry a lower interest rate than the debts you are combining into your mortgage.
While a lower interest rate can mean a lower monthly payment than the total of your individual payments, whether you save money will depend on the term of your loan. It is very important to understand that interest is still being charged on your new loan. The longer your mortgage or loan amortization is, the more interest you will pay. The shorter the amortization period means less interest but a higher payment.
As well, it is important to note that a debt consolidation loan does not reduce your total debt. If you consolidated $50,000 in credit card debt, you end up with a $50,000 home equity loan or second mortgage. Your total debt has not decreased. Only the interest rate has decreased.
You should also be aware that you have now transformed your unsecured debt into secured debt either by increasing your current mortgage or by placing a second mortgage on your home.
When a Second Mortgage is Not a Good Option
A concern with a secured debt consolidation loan is the risk that you may lose your home if you default on your payments. If your debts are more than you can reasonably repay even when rolled into your mortgage, debt consolidation may not be the best choice. If you suddenly become unable to make your mortgage payments, your lender will likely take action to recover their loan by foreclosing on your house.
A second mortgage is also not a good solution if it does not deal with all your debt problems. If you have debts that cannot be combined into your mortgage, or you continue to use your credit cards and accumulate new debts, you could find yourself owing more than you did when you started.
A Consumer Proposal is not a Loan
A consumer proposal is like a consolidation loan, except you don’t borrow any money. You just start making payments and it’s interest free. Filing a consumer proposal allows you to maintain control of your assets and keep your home by making a proposal to pay the equity in your home to your creditors over a period of time. It is not a new loan; it is a payment over time. And the interest clock stops.
A consumer proposal is also a good option if the total amount of all your unsecured debts exceeds the equity value in your home. Even if your equity is greater than what you owe, it can still be a viable option if you are getting harassing collection calls.
How much you will have to pay will depend upon the equity in your home, the amount of unsecured debt as well as your income; however, it is certainly a viable option for consolidating high interest or multiple unsecured debts and/or even tax debt. An LIT can provide a complete assessment of your situation and outline the payments.
Let’s assume you have sufficient equity in your home to pay your debts in full and let’s assume you choose the Consumer Proposal route. We have set out below a schedule of what it would cost an individual to pay their creditors in full plus the fees of the LIT. We have used a range of between $50,000 and $100,000 of debt. We have calculated the amount of the LITs fees utilizing tax rates in British Columbia. The actual fees would be the same across the country. The total cost would range between $65,144.64 and $128,435.78.
A Consumer Proposal has a maximum term of 60 months. Monthly payments would range between $1,085.74 and $2,140.60. The fees of the LIT are calculated in accordance with Rules set out in the Bankruptcy and Insolvency Act. There are be no additional costs or fees and no interest.
Now if you wanted to borrow the money to pay off your debt through a consolidation loan, a second mortgage or refinancing of Home Equity Loan, we have set out a table below showing the cost of borrowing.
If you borrowed the same amounts at 11% amortized over a five-year term, the cost of borrowing ranges between approximately $15,227.27 and $30,454.54 which is slightly more than the proposal. This utilizes the same term as a consumer proposal. The total amount paid under the proposal is almost exactly the same. However, if you have a variable interest rate, which could easily change over the term of the mortgage, the cost of borrowing would rise. It also doesn’t consider any fees that may have to be incurred for appraisal and legal fees that are usually extra.
As you can see, the cost between the two options is not very different at all. However, should the term of the loan be longer than 5 years or the interest rate be different than set out above, the cost of borrowing would certainly be more expensive. The consumer proposal has no such variables.
The other intangible is qualification. You will have to qualify for the loan and arrange for a lender who probably wants an appraisal etc. This all takes time. Meanwhile your creditors are pressuring you for payment and threatening enhanced collection action.
To qualify for a consumer proposal, you only need to owe less than $250,000 (not including the mortgage on your principle residence). A proposal to your creditors can be prepared and signed in a very short time. The other advantage is that it then provides you the certainty of retaining your home.
What if I can’t afford to pay the monthly amount under the consumer proposal?
As we all know, it is not cheap living in Metro Vancouver. So what if you can’t afford the monthly payment under a consumer proposal. Don’t worry. There is another option. A Division I proposal is available to lengthen the term and lower the payment. And yes, it is still interest free.
Is a Debt Management Program Better?
Some would argue that a Debt Management Program (“DMP”) is a better option as you only pay 100% of your debt as opposed to 100% of you debt plus fees. That is a misconception and a misrepresentation of the facts.
A DMP in this scenario would not only have you pay 100% of the debt but the fees of the DMP Company as well. The DMP Company gets paid a monthly fee from the debtor of about 10% of the monthly payment but, it typically maxes out at about $75 per month and they receive funds from the creditors for administering the plan. The fee they receive is usually around 22%.
Using these figures the total cost of a DMP for $50,000 would be approximately $65,500. Creditors receive full payment.
Can I Pay Off my Consumer Proposal Early with a Mortgage or other borrowings?
As previously stated, a consumer proposal is like a consolidation loan, except you don’t borrow any money. You just start making payments and it’s interest free. To borrow money to pay off a consumer proposal doesn’t make good financial sense. You will be paying interest on the loan whereas you can maintain the payment in the proposal which is interest free. It would, however, start the three-year time period that a consumer proposal remains on your credit record earlier.
As well, until your consumer proposal is paid in full, it may be difficult to convince a lender to lend you more money because they are likely worried that if you default on your proposal, all your old debts are revived and can return.
In our view, a consumer proposal is a better option than a Home Equity Loan, second mortgage or Debt Management Plan for the following reasons:
- There is one monthly payment;
- It includes all creditors, even income taxes.
- The proposal is interest free. Once accepted by the creditors, there are no variables that would change the terms or the final cost;
- There is no credit check and no qualifying; and
- You get to retain the equity in your home.
|Consumer Proposal||Refinancing, 2nd mortgage, HELOC, DMP|
|One monthly payment||Risk of foreclosure|
|Interest free, no future variables||Less equity in home for the future|
|Includes all creditors||DMP cannot include government debt|
|No prepayment penalty||Possible penalty for early payout|
|No credit check or qualifying||Additional costs fees, qualifying|
|Retain equity in home||Interest rates fluctuations|
|Debt free and fresh financial start|
In all cases, to achieve a fresh start, a consumer needs to change the habits that got them here in the first place. They need to get their spending under control.
Before you take out a second mortgage on your home to pay off credit card or other unsecured debts, talk to an LIT about your options. Find out if a consumer proposal will save you more money in the long run. Don’t rush to make a decision before you make an expensive mistake.