What happens when I make a Consumer Proposal? Will it destroy my credit?

The impact of a Consumer Proposal on your credit

Let’s start by acknowledging that a Consumer Proposal is a negative item that will be disclosed on your credit report, and it stays on your report for the period of your proposal, plus an additional three years. However, whether it's destructive to your ability to obtain affordable credit depends on several factors:

1. The state of your credit prior to filing a Consumer Proposal

There are other things that are bad for your credit which, if they relate to your situation, may mean that your ability to obtain affordable credit is already negatively impacted similar to the impact of a Consumer Proposal:

Bad payment history

Your payment history accounts for a large portion of your credit score – by some accounts it impacts 35% of your score. If you’ve had a lot of late or missed payments, have accounts in collection, or have had an account closed by the lender due to non-payment, it will have a serious impact on your credit rating. It’s not uncommon for an individual considering filing a Consumer Proposal to already have a lot of items on their credit report which indicate a bad payment history.

Maxing out your credit

The extent to which you’ve used your credit may account for approximately 30% of your credit score. The Government of Canada recommends 35% as the ideal amount of your credit limit to use, but individuals who are considering making a Consumer Proposal have often already used 100% of their credit limit on most of their credit facilities (ie. they’ve maxed out their credit cards and lines of credit). This can have a serious negative impact on your rating.

Lack of established credit history

Some say that up to 15% of your credit rating is based on the length of time you’ve been using your existing credit facilities. The longer you can show a good history on an active account, the better. However, it isn’t uncommon for those considering making a Consumer Proposal to have taken out new debt in the recent past. Sometimes, they’ve tried consolidating their debts, closing down old accounts with a good track record in favor of a new account with a lower interest rate. Even if you’ve had a good track record with a new account, it won’t hold much weight with lenders. They want to see currently active accounts that have been in good standing for a long time.

Don’t forget, it’s not just your bills that need to be in good standing. If you’ve co-signed someone else’s debt or are a joint holder of debt with someone else, their missteps will already have impacted your credit rating. It’s a good idea to pull your credit report to see what you’re starting with before deciding that the negative impact a Consumer Proposal has on your credit rating is going to make a difference for you.

2. A good credit score doesn’t necessarily mean you’ll be approved for affordable credit

If you’ve always meticulously kept up with your payments and made sure to clear up any errors, you may have a decent credit score (based on the reports you pull from the credit agencies) despite having made some of the mistakes above. But that doesn’t necessarily mean that lenders will look favorably on you. They sometimes ignore the credit score you see and calculate one on their own based on the details found in your credit report. A relatively sophisticated lender (which tend to be the ones that can offer an affordable interest rate) may be able to sniff out signs that you’re insolvent even if your credit score looks okay. In that case, you likely already will have trouble obtaining affordable credit.

3. There may be more important things than your immediate credit score

It feels good to have a decent credit score and to know (or at least think) that you can get access to more credit if you need it. But it’s important to step back and evaluate whether that’s truly important right now. If you don’t have an immediate need for new credit, then the impact on your credit rating likely won’t make much difference in your life in the short term. And while a Consumer Proposal will show up on your credit report for three years after you complete it, it won’t necessarily impact your ability to get affordable credit while it stays on there. Lenders look at all of the details in your credit report and decide whether to offer you credit (and at what rate) based on a lot of things, not just the score you see on your report. If you get started on credit-building strategies immediately after filing a Consumer Proposal, you may find that you can get affordable credit within a year or two after finishing your proposal payments. By then, you’ll likely be in a better financial position to make down payments on assets and keep up with the debt payments, so the timing often works out well.

Right now, if your debt is overwhelming you, it may be more important to get the relief offered by a Consumer Proposal and focus on rebuilding. This often has the effect of shortening the time period to improving your credit when compared to toughing it out for years trying to keep up with payments.

Re-building your credit

A Consumer Proposal can be a starting point for improving your access to credit in the future. By dealing with the debt that’s impacting your credit rating already and providing the breathing room you need to get off the debt treadmill you’re on, you can start anew with healthy debt relationships that will increase your credit rating going forward. And if you have the ability to make a lump sum proposal (meaning you make only one [larger] payment up front), you can immediately start the clock on the three-year timeframe for the Consumer Proposal to stop showing up on your credit report. In that case, a Consumer Proposal may be the fastest way to fix your debt and credit-rating problems.

As you can see, the impact a Consumer Proposal has on your ability to access credit depends on your situation, so if you’re not sure how a proposal would impact you, you may want to consider contacting a Licensed Insolvency Trustee for a consultation. When you do so, the Licensed Insolvency Trustee can also talk to you about other options that may work better for you.

Charla Smith & Company is a Calgary-based Licensed Insolvency Trustee, serving the southern Alberta region. We regularly help individuals navigate their options for dealing with overwhelming debt. If you would like a free, no-commitment consultation to review your options, contact us.

Disclaimer: This publication provides general information and should be seen as broad guidance only. The information contained herein cannot be relied upon to cover specific situations and you should not act, or refrain from acting, upon this information without obtaining specific professional advice relating to your particular circumstances. Charla Smith & Company Ltd. does not accept or assume any liability or duty of care for any loss arising from any action taken or not taken by anyone in reliance on the information in this publication or for any decision based on it.