What is the difference between secured and unsecured debt and why is it important?

September 10th, 2014 by Mark Silverthorn

Secured debt and unsecured debt

Not all debt is created equal. Your debts fall into one of two categories, secured and unsecured debt.   If you are considering filing for personal bankruptcy or making a consumer proposal then this distinction can be critical.  If you were to file for personal bankruptcy or make a consumer proposal then you would only receive protection from your unsecured creditors.  Neither personal bankruptcy nor a consumer proposal provides you any relief from your secured creditors!

Secured debt and unsecured debt


What is secured debt?

A secured debt is a debt where your creditor has collateral it can go after if you are unable to pay.  The two most common examples of secured debt are the mortgage on a home and a lien when you finance the purchase or lease of your car.  If you fail to make your mortgage payments your lender can force the sale of your home.  Similarly, if you stop making your car payments your lender might choose to seize your vehicle.

Some consumers have signed a Master Credit Agreement with a financial institution providing the consumer with a specific dollar amount of credit.  As part of this Agreement the financial institution typically obtains a mortgage on the consumer’s home.  Under this Master Credit Agreement the lender is a secured creditor in connection with any credit extended to the consumer. This might include a mortgage, a line of credit, credit cards, and overdraft protection.  If you have signed a Master Credit Agreement then all of the debts arising from that Agreement would be a secured debt.

Unpaid property taxes are considered to be a secured debt because the municipality has a lien on property for unpaid property taxes.


What is unsecured debt?

Any debt that is not secured debt is unsecured debt.  An unsecured debt is a debt where your creditor has no collateral in the event you were not to pay it.  In Canada today, most, but not all, credit cards are unsecured debt.  Some, but not all, lines of credit and personal loans—particularly for smaller amounts—are unsecured debt.  Conversely, most lines of credit and personal loans for larger dollar amounts are secured debt.  Furthermore, any monies that you owe to the government for income taxes or student loans are unsecured debt.  Finally, the monies that you owe to phone companies, internet service and cable television providers are unsecured debt.


A creditor might be able to transform your unsecured debt into secured debt

Depending upon the circumstances, a creditor might be in a position to transform your unsecured debt into secured debt.  Your unsecured creditor might be able to successfully sue you and place a lien against any of your real property, and in the process become a secured creditor.  This remedy is available where you, now or in the future, own real property in your own name.  Real property includes assets such as a detached house, townhouse, condominium, cottage, rental property, farmland as well as commercial real estate.

It is common for consumers who are experiencing financial problems to put their real property up for sale. This decision can have a number of advantages. Firstly, the proceeds from the sale of the real property might generate some much needed monies and improve the consumer’s cash-flow situation. Secondly, this action might make it much more difficult for creditors to recover any monies from the consumer.
 

Secured creditors are more likely to recover monies than unsecured creditors

Secured creditors usually, but not always, are able to recover all, or some, of the monies owed to them when a consumer fails to make their payments.  In contrast, unsecured creditors, particularly when it comes to consumer debt, are less likely to recover monies from a consumer who stops making payments.  Interest rates on credit cards are high, in part, because a credit card company must take into account the fact that anywhere between one and three percent their customers will default making their credit card payments.

Secured creditors are able to look to their security interest to recover monies from a consumer in default.  The key concern for secured creditors is the size of their security.  Is it large enough to satisfy the amount of money the debtor owes the creditor?  A financial institution which holds the first mortgage on a house should be able to recover one hundred percent of monies owing on a mortgage loan provided the house’s market value is greater than the amount owed by the consumer.

There are a number of scenarios under which an unsecured creditor will not recover some, or all, of monies owing to it:

  1. Consumer is unwilling or unable to pay their outstanding debt voluntarily
  2. Consumer files for personal bankruptcy or successfully makes a consumer proposal
  3. Consumer dies and the estate is not able to pay the outstanding account
  4. Consumer does not own real property and the creditor cannot take advantage of a wage garnishment to recover monies owing
  5. Creditor does not want to sue the consumer
  6. Consumer is judgment proof
  7. Limitation period on a consumer debt has expired

Unsecured consumer debt and limitation periods

Secured LoanIf you have an unsecured debt it will fall into one of two categories, consumer debt or non-consumer debt.  Non-consumer debt includes any monies owing to the government as well as obligations arising from court-ordered child support or spousal support.  Unsecured consumer debt includes any unsecured debt except for court-awarded child support or monies owing to the government.

Provincial governments have enacted laws which strongly discourage unsecured consumer creditors from suing consumers owing money to them after a certain time period.  These are known as limitation periods.  Any creditor who considers suing a consumer after the expiry of the relevant limitation period—the one for the province where the consumer lives—is at a major disadvantage.  The following table sets out limitation periods for contract debt in each province and territory in Canada.

Summary of Canadian limitation periods by Jurisdiction, for contract debt

Province or Territory Length of Limitation Period in years Significance of expiry of limitation period
B.C. 2 Gives rise to affirmative defence
Alberta 2 Gives rise to affirmative defence
Saskatchewan 2 Gives rise to affirmative defence
Manitoba 6 Gives rise to affirmative defence
Ontario 2 Gives rise to affirmative defence
Quebec 3 Gives rise to affirmative defence
New Brunswick 2 Gives rise to affirmative defence
Nova Scotia 6 Gives rise to affirmative defence
Newfoundland 6 Debt extinguished
PEI 6 Gives rise to affirmative defence
NWT 6 Gives rise to affirmative defence
Nunavut 6 Gives rise to affirmative defence
Yukon 6 Gives rise to affirmative defence

Taking advantage of a limitation period only available on unsecured consumer debt

You cannot take advantage of the expiry of a limitation period on your secured debt.  Nor can you can take advantage of the expiry of a limitation period on unsecured debt which is not consumer debt.  Accordingly, you cannot take advantage of a limitation period for court-ordered child support or spousal support or for monies owed to the government.


Relevant limitation period is the one for the province in which you reside

The relevant limitation period is the one for the province in which you reside.  The limitation period for contract debt is two years for the residents of Alberta, British Columbia, New Brunswick, Ontario, and Saskatchewan, and three years for Quebec residents.  The relevant limitation period for Canadians living outside these provinces is six years.


The clock on the limitation period starts to run when the debt arises

It is very helpful to think of a limitation period as a clock.  The clock on the limitation period on your unsecured consumer debt begins to run when you default on your obligation.   This almost always means that the clock on your limitation period starts to run on the date of your last payment or possibly 30 days thereafter.  In some instances a consumer might fail to make any payments whatsoever in which case the clock on the limitation period starts to run on the date when your creditor would have the right to sue you for non-payment.
Erase Debt


Actions by a consumer which can restart the clock on a limitation period

There are two things that a consumer can do to restart the clock on a limitation period.  Firstly, if a consumer makes a partial payment—before the expiry of the limitation period—then the clock on the limitation period will restart on the date of the partial payment.  Secondly, if a consumer signs a written document acknowledging that the consumer owes money to the creditor—before the expiry of the limitation period–then the clock on the limitation period will restart on the date of the written acknowledgement.


The consequences of the expiry of a limitation period

Depending upon which province you live the expiry of a limitation period will have different consequences.  If you live in Newfoundland and the province’s six-year limitation period for unsecured consumer debt has expired then your debt is extinguished.  In Newfoundland after the expiry of the limitation period then your creditor should not be able to sue you because the debt no longer exists.

If you live anywhere in Canada other than Newfoundland, however, then the expiry of a limitation period merely gives rise to an affirmative defence. If you were to be sued after the expiry of a limitation period–and you live outside of Newfoundland–then it would be necessary for you to defend the lawsuit and plead the expiry of province’s statute of limitations as a full and complete defence. Under these circumstances, you should be able to successfully defend the lawsuit and your creditor should lose the lawsuit. If you live outside of Newfoundland and you are sued after the expiry of a limitation and you fail to file a defence and plead the expiry of the province’s limitation period in your defence then your creditor could obtain a judgment against you.
 

For twelve years, between 1995 and 2007, I worked as a collection lawyer for four of the ten largest collection agencies operating in Canada.  Based upon my knowledge of the collection industry, most creditors will not sue an unsecured consumer debt after the expiry of a limitation period.


How does the passage of time affect an unpaid unsecured consumer debt?

There are three separate and distinct issues that arise in connection with the passage of time and unpaid consumer debt:

  1. After how many years can a consumer avoid paying an outstanding unsecured consumer debt because of the expiry of the relevant limitation period?
  2. After how many years will a delinquent account be removed from a credit report?
  3. After how many years will collection calls stop?

Once your unsecured consumer debt is six months in default most creditors will have hired a collection agency to collect your account on commission basis.  Once the limitation period on your unsecured consumer debt expires it is going to be difficult for your creditor to collect it and the odds are remote that you will be sued.

If you stop making payments on an unsecured consumer account then your creditor will typically report this to a credit reporting agency and this will appear on your credit report.  A poor credit score affects whether or not you are able to obtain credit and. if so, how expensive it is for you to borrow money.  Under provincial law, an unpaid account will show up on your credit report for six years from the date of your last payment after which, by law, it is supposed to be automatically removed from your credit report.

The fact that a limitation period has expired, however, does not discourage collection agencies from calling consumers to demand payment of an unpaid account.   Newfoundland is the only province where the expiry of its six-year statute of limitations extinguishes a debt and prevents anyone from making further lawful payment demands.  Creditors and collection agencies routinely demand payments from consumers after the expiry of a limitation period on an outstanding account.  The chart set out below summarizes when a creditor or a collection agency can lawfully demand payment of an unpaid consumer account is more than six years old.


Law As To When Collection Calls Are Legally Permitted After a Debt Is More Than Six Years Old

Province/Territory Collection calls permitted
by creditors
Collection calls permitted by collection agencies
British Columbia x x
Alberta x
Saskatchewan x x
Manitoba x x
Ontario x X
Quebec x X
New Brunswick x X
Newfoundland
Nova Scotia x x
Prince Edward Island x x
NWT x x
Nunavut x x
Yukon Territory x x

If you live outside of Alberta or Newfoundland there is no law preventing your original creditor, its authorized collection agent, or a debt buyer who has purchased your debt from contacting you and demanding payment of a debt that is six, ten, 15, or 20 years outstanding.  In many circumstances, however, there are actions that a consumer can take to stop collection calls from a collection agency or a creditor, particularly where the debt is owed to a financial institution.


If you want to learn more about how you can deal with your current debt situation you can speak to a Licensed Insolvency Trustee about filing for personal bankruptcy or making a consumer proposal.

Mark Silverthorn
Mark is a former collection lawyer, collection industry insider and author.

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