8 Lies About Debt You Probably Believe
Debt is common battle for millions of Canadians and you probably understand the causes and ways out, right?
In some ways, debt and personal finance is really simple. But things often get complicated when big assets like your home, car, and long-term credit rating get involved. From billboards promising to get you debt free to newspaper articles warning about unethical debt settlement companies, you suddenly have a bunch of different experts telling you what to do and the giant traps to avoid.
Here are 8 lies about debt that you probably believe.
LIE #1: You Own Your Debt
There’s an excellent article in the New York Times, which explains the underworld of consumer debt collection. I recommend reading it.
Did you know that your unsecured debt (car loans, high interest loans, and other small debts) can be sold and passed around to different collection agencies?
Once a consumer goes into default and starts skipping payments, they become a high-risk investment. So, large firms will typically sell this debt for pennies on the dollar.
As the New York Times reports, once a consumer stops paying their bills, the “value” of that debt to banks begins to fall. They often look to offload and sell your debt.
When debtors stop paying those bills, the banks regard the balances as assets for 180 days. After that, they are of questionable worth. So banks “charge off” the accounts, taking a loss, and other creditors act similarly. These huge, routine sell-offs have created a vast market for unpaid debts — not just credit-card debts but also auto loans, medical loans, gym fees, payday loans, overdue cellphone tabs, old utility bills, delinquent book-club accounts. The scale is breathtaking. From 2006 to 2009, for example, the nation’s top nine debt buyers purchased almost 90 million consumer accounts with more than $140 billion in “face value.” And they bought at a steep discount. On average, they paid just 4.5 cents on the dollar. These debt buyers collect what they can and then sell the remaining accounts to other buyers, and so on.
While this is a US article, the process is no different in Canada.
This is actually a good thing, for you.
Because your debt is a commodity on the market (and because you haven’t been paying it off and missing payments) you are a high-risk investment.
Creditors no longer care that you originally borrowed 30K. They aren’t aiming to get all that back—they just want to salvage and get some money from you, as they also know by this point you likely have problems with your mortgage, cable bills, and other creditors trying to extract money from you.
This is the biggest secret about debt: just because you owe 30K doesn’t mean you’ll have to pay all that back. You are dealing with multi-billion dollar companies—they are often fine with taking a huge reduction as they are looking to recoup something on their investment.
Now, some of the “debt settlement” companies that promise this don’t actually deliver. Or they are Canadian shell companies with call centres based in the US who actually make their money by charging you heavy upfront fees and not being able to successfully resolve your issue.
This is why you have more power than you realize. Unlike the credit counselling agencies that will usually put you in a program to repay 100% of your debt plus interest, you have the power to make an offer to your creditors and work out an agreement.
LIE #2: That You Actually Can Declare Bankruptcy
It’s the secret parachute we all have thought about. If the business fails or my student loan debt grows unmanageable, bankruptcy is the reset button. It’s not the option we all want but it’s there as a possible exit.
But it’s much harder to fulfill the duties under a bankruptcy than most Canadians realize. This is particularly true if you have assets or a reasonable household income.
The truth is that to file bankruptcy you need to meet a number of conditions before you are discharged from bankruptcy. You’ll also need to prove that you are actually insolvent instead of capable of paying down your debt over time.
That’s why a large number of Canadians who consider filing bankruptcy actually end up filing a consumer proposal. A consumer proposal is a less extreme way to get out of unmanageable debt. Even Licensed Insolvency Trustee's will generally suggest a consumer proposal over bankruptcy in many situations.
LIE #3: Licensed Insolvency Trustee's Work for You
When we think about filing bankruptcy, we often think that we will be in the hands of court. In some ways this is true. But you will actually have to pay fees to your trustee and just because you are paying their fees this does not mean they are representing you.
In fact, a trustee isn’t appointed to you. You choose one.
The role of the trustee is to ensure that everything is done within the parameters set by the Bankruptcy and Insolvency Act and that both you and your creditors follow all bankruptcy rules. The definition of the trustees role is as follows:
‘The trustee is an officer of the court who acts on behalf of the creditors in a fiduciary capacity’
In plain English, this means that your trustee isn’t neutral. They have a duty to recover assets on behalf of the creditor.
LIE #4: Your Credit Rating MUST Be Protected at All Costs
We live in a society of credit. It’s no surprise that one of the huge fears around bankruptcy and consumer proposals is that they impact your credit rating.
The implication is that if you ruin your credit rating, you’ll be forced to pay predatory rates (such as the next time you want to buy a car) and will be prevented from buying a home.
The truth is that credit is easier to repair than most people realize. And if a hit to your credit rating means saving yourself $50,000 in debt, which would keep you in relative poverty for 8 years, then the choice is obvious.
Your credit rating is important but should not be preserved over financial decisions that could get you out of debt and put you on a more solid financial path.
LIE #5: Non-Profit Credit Counselling Agencies Are Altruistic
Ever wonder why non-profits offering ‘credit counselling’ are so eager to give you advice? Ever wonder how they can afford to advertise on TV?
Most non-profit credit counselling agencies are actually financed by credit cards and banks. Why would a bank finance a non-profit?
The basic explanation is that credit counselling agencies typically offer “debt management” advice. In other words, they direct you towards debt relief options that are more beneficial to creditors. They tend to suggest debt management programs which you are paying back every penny you borrowed.
Even though you are paying back 100% of your debt there is still a significant impact on your credit rating because you aren’t paying back the debt on the original terms and conditions. So by working with a company funded by the creditors to help people in financial difficulty and paying back 100% of the debt will still have the same impact on your credit rating as other debt restructuring options were you only pay back a fraction of the debt. It seems harsh but it is reality.
In short, these non-profits will often recommend a course of action that benefits the banks and lenders, not the consumers. While they can offer some good advice (such as budgeting tips and managing the stress of debt), they aren’t impartial sources of information. Often, you’ll have to pay for some of their services as well.
LIE #6: Consumer Proposals Are a Bad Choice to Deal with Debt
One big misconception about debt is that consumer proposals are either a scam or generally a very un-smart thing to do from a long-term financial standpoint. Yes, consumer proposals do have their advantages. But, they serve a specific purpose and are typically used when debt climbs to unmanageable levels.
The reason why consumer proposals get a bad rep is that personal finance bloggers tend to not like them. That’s because personal finance is really about living debt free. But a consumer proposal isn’t designed as a casual debt reduction technique. Consumer proposals help people when they have high levels of unmanageable debt. When frugal living and budgeting isn’t cutting your debt, often a consumer proposal is the most sensible option.
They are also completely legal and acceptable way to deal with large sums of debt and provide an alternative to bankruptcy. It’s a less extreme measure and if structured correctly often a very good option for Canadians with large amounts of debt. It’s important to remember that dealing with debt is only one piece of the puzzle and you need a comprehensive plan to effectively manage your money and reestablish your credit rating to make any debt restructuring program successful.
LIE #7: People Go Into Debt Because They Are Irresponsible
We’ve worked with thousands of families in Canada. We’ve found that the final weight that tips the scale—moving them from debt to a dire financial crisis—is something small. The car breaks down and it’s that last unexpected expense that topples the house.
A lot of people think that debt is a result of poor decision making. We’ve found that it begins slow, grows more urgent, and then finally collapses your cash flow. Most of our clients are typical middle-class Canadians including police officers, teachers, bus drivers, and factory workers. They aren’t irresponsible. They are just the product of a series of small, misguided financial decisions.
When building a debt management plan, you need to account for unexpected expenses and cash flow. Even people in debt should be saving towards an emergency fund—without a holistic view of your finances, you are very vulnerable.
This is why you need to be careful about the dangerous debt cycle. Building an emergency fund (start with $1,000) is more important than paying every penny you can to your credit card.
LIE #8: You Can Budget Your Way Out of Debt
There’s a big difference between debt and a financial crisis.
Most people in debt have simply outspent their earnings. They bought a new kitchen, over extended themselves on a mortgage and car payments. Credit became essential to meet their day-day living expenses. Now, they are 20K in debt and need to roll up their sleeves, earn some extra money, budget, and start a debt snowball.
I really admire the stories about debt at the YNAB blog. BUT, there’s a big difference in how you how you get out of debt and how you survive a financial crisis. For some even the most extreme budgeting and drastic lifestyle cuts cannot solve the problem as the income simply can’t meet the fixed costs and the required debt payments.
The truth is that debt can quickly become a financial disaster and that’s where many Canadians lack the skills or knowledge to deal with high levels of debt.
This is where you lose your home.
This is where the lawsuits begin.
This is where the savings, RRSPs are cashed out, insurance payments are paused, and bankruptcy becomes a consideration.
The BIG LESSON is that many Canadians miss the warning signs for when debt begins to turn into a financial crisis. When you begin to miss mortgage payments, lose sleep, and live under an incredible burden of debt, that’s when budgeting and simple personal finance tricks aren’t the right solution.