What to do if you can’t pay your credit card debt?
Did you know that only 25% of Canadians pay off their credit card debt in full each month.
That means 75% of us carry a balance on our credit cards each month. In fact, it’s quite common for Canadians to carry outstanding balances each month on several credit cards which can result in paying several thousands of dollars each year in interest.
Important things to know if you have more credit card debt than you can handle.
- In the short term, what are my options if I cannot make my credit card payments?
- In the long term, what are my options if I cannot make my credit card payments?
- How can I minimize the negative consequences of no longer having access to a traditional credit card?
Your options in the short-term if you cannot make your credit card payments
If you are unable to make the payments on your credit cards then you will be faced with some important decisions. Some of these decisions could be described as short-term decisions, ones that need to be made sometime over the next few days or couple of weeks.
- Stop making payments on all but one or two of your credit cards
- Stop making payments on all of your credit cards
- Stop making payments on all your credit cards and obtaining a pre-paid credit card
Consequences of your failure to make minimum monthly payments
If you stop making the payments on your credit card then there will be consequences:
- Loss of entitlement to rewards under credit card’s rewards program
- Your creditor will attempt to collect money from you
- Negative impact on your credit score and your credit report
- Potential adverse consequences from the “right of set off”
“Something you need to consider before making the decision to stop making payments on a particular credit card is whether or not you will experience adverse consequences arising from a financial institution’s right of set off. If you obtained your credit card through your financial institution then it will typically be in a position to exercise what is called a right of set-off.”
An example will help illustrate a consumer’s exposure where a financial institution can exercise a right of set off. Joan Smith, like a significant percentage of Canadians, deals with only one bank. Her bank is the ABC Bank, where she has one bank account. She obtained her VISA, her only credit card, through ABC Bank. Furthermore, she gets her paycheque deposited into her bank account at ABC Bank by direct deposit. She also gets here baby bonus payments from the government deposited directly into this account.
Joan Smith pays her rent and her car monthly car insurance payment using a Pre-Authorized Debit on her bank account at ABC Bank. Joan Smith also pays a number of monthly utilities—cable television, internet, and cell phone bills–using a Pre-Authorized Debit on her ABC Bank VISA credit card. Joan Smith has a $10,000 credit card limit on her ABC Bank VISA. She currently has $600 in her bank account at ABC Bank, enough to cover next month’s rent. This month Joan Smith’s minimum monthly payment on her ABC Bank VISA is $200 or 2% of her $10,000 outstanding balance. She cannot afford to make this payment because she needs to pay her rent as well as some unanticipated car repairs.
If Joan Smith does not make her $200 minimum monthly payment on her credit card then ABC Bank will be in a position, under the right of set-off, to simply take $200 from her bank account at ABC Bank and use it to make her minimum monthly payment on her ABC Bank VISA credit card. In order for Joan Smith to avoid this she needs to either (1) close her bank account at ABC Bank or (2) withdraw the $600 from her bank account at ABC Bank. Because ABC Bank is now in a position to exercise a right of set-off against Joan Smith then no money on deposit at her bank account at ABC bank account is safe.
Ideally she should do the following as soon as possible:
- Close her bank account at ABC Bank or withdraw all or virtually all of the money she currently has on deposit in that account
- Open a new bank account at another financial institution
- Deposit some money into her new bank account at her new financial institution
- Contact her employer and arrange to have her paycheque deposited into her new bank account
- Contact the government and make arrangements for her baby bonus cheques to be deposited into her new bank account
- Contact her creditors to whom she was making monthly payments using Pre-Authorized Debit payments—from her bank account at ABC bank account and provide them with authorization for Pre-Authorized Debit payments from her new bank account
- Contact her creditors to whom she was making monthly payments using Pre-Authorized Debt payments using her ABC Bank VISA—and make alternative arrangements for paying these creditors
The pre-paid credit card: an alternative to a traditional credit card
If you are going to stop making payments on all your credit cards then you might be asking yourself how are you going to be able to rent a car, book a hotel room, or make an online purchase in the future? Fortunately, today there are pre-paid credit cards which can be very helpful if you are no longer able to use credit cards.
1. Who might want to obtain a pre-paid credit card?
You might want to consider obtaining a pre-paid credit if you fall into one or more of the following categories:-You are experiencing difficulties making your payments on your credit card-You are experiencing problems making payments on your personal loans or lines of credit-You owe money to Canada Revenue Agency (CRA)-You have outstanding judgments against you-You owe money to creditors-You are using your credit cards to make purchases that you cannot afford to make
2. What is a pre-paid credit card?
A pre-paid credit card is similar to a traditional credit card in that it provides the cardholder with a convenient method of purchasing goods and services. If you have a pre-paid credit card you can use it for car rentals or booking hotel rooms. You can also use it to make recurring payments such as your monthly internet, cable television, or cellphone bill. Unlike traditional credit cards, a pre-paid credit card does not provide the consumer with access to credit. In order to be able to use a pre-paid credit card the consumer must first put money on the card. As a person uses the pre-paid credit card the balance on the card runs down and at some point it is necessary to put additional money on the card otherwise the card can no longer be used to make purchases.
3. Why can a pre-paid credit card be a debtor’s best friend?
Obtaining a pre-paid credit card can be incredibly helpful for a person who can no longer make the payments on their traditional credit card. There are two key reasons why a pre-paid credit card can be a great asset for anyone experiencing financial difficulties:-A person with bad credit or no credit history can obtain a pre-paid credit card-Some pre-paid credit cards can shield you from your creditors If you owe monies to CRA or if you have other creditors particularly creditors with judgments against you, then a pre-paid credit card can be very useful because they might not require you to have a bank account. Ideally, if you owe monies to CRA or other creditors then you want to avoid having monies on deposit at a financial institution where, at some future date, your monies on deposit might be subject to seizure. You can, for example, obtain a pre-paid Titanium VISA credit card at a Money Mart.
The difference between unsecured and secured credit cards
There are two different types of traditional credit cards, secured and unsecured. In many respects secured and unsecured credit cards are the same. They both offer easy access to credit, a convenient way of paying for many goods and services and certain credit cards might offer some type of rewards program. Secured and unsecured credit cards, however, are very different when it comes to the credit card company’s rights where a consumer fails to make their payments on the credit card. In the case of a secured credit card, the credit card company has collateral it can go after in the event the cardholder does not make his credit card payments.
The most common collateral used on a secured credit card is the cardholder’s home. Some Canadians have signed a Master Credit Agreement with a Canadian financial institution under which the consumer receives access to a certain amount of credit in exchange for collateral, typically a mortgage on the consumer’s residence. If a credit card company issues a credit card to a consumer and does not take some kind of security interest then it is an unsecured credit card.
A significant percentage of credit cards in Canada are unsecured. In the event that a consumer with an unsecured credit card stops making payments then the credit card company has no collateral to look to in order to recover its monies. A credit card company seeking to collect monies on an unsecured credit card will be virtually in the same position as any other unsecured consumer creditor.
Collection strategies employed by unsecured consumer creditors
Large creditors in Canada—financial institutions, credit card companies, retailers, and utilities providing internet, cable television, and telephone services—employ similar strategies when collecting unsecured consumer accounts. The purpose of this section is to describe how creditors owed unsecured consumer debt, more specifically large creditors, attempt to recover monies owed to them. The comments contained in this section might not apply to small creditors like your dentist, veterinarian, or lawn care company. Nor do they apply to governments who often have extraordinary powers when it comes to collecting monies owed to them. For the first three to six months that your account has not been paid persons working in your creditor’s in-house collection department will attempt to call you requesting payment of your account. During this period your creditor will likely send you written notices demanding payment.
In some cases, during the first six months that your account is overdue you might receive a generic-looking letter from a lawyer demanding payment on behalf of your creditor. If you receive a demand letter from a lawyer on behalf of your creditor within the first six months that your account is overdue then the odds are it is a mass-produced computer generated letter and no lawyer has looked at your file. These letters from lawyers are used to intimidate consumers and they are used because they are often effective at generating payments. Once your account has been unpaid for six months then your creditor has a number of options and will do one of the following:
- Continue collection efforts using its in-house collection department
- Hire a collection agency to collect your account on a commission basis
- Sue you
- Sell your outstanding account
If your account continues to remain unpaid, at some future date, your creditor might change course and try a different option. For example, a creditor might assign your outstanding account to collection agencies for collection on a commission basis, and after your account remains unpaid for a period of three years it might sell your account to a debt buyer. Collection agencies collecting accounts on a commission basis Large creditors have tens of thousands, and in some cases, hundreds of thousands of outstanding accounts. The most cost effective way for a creditor to make money on its portfolio of bad debt is to simply farm it out to one or more collection agencies on a commission basis. A creditor does not pay any fees to a collection agency on those accounts where a collection agency does not recover any monies from the consumer. The three primary activities of collection agencies can be described as follows:
- Attempting to locate current contact information for debtors
- Phoning debtors and making demands for payment
- Sending collection notices to debtors by regular mail and making demands for payment
In some instances a collection agency might sue a debtor on behalf of a creditor
Suing debtors, however, is not a common activity for collection agencies. Based upon my research for my book The Wolf At The Door: What To Do When Collection Agencies Come Calling (2010), published by McClelland & Stewart, I estimate that collection agencies, collectively across Canada, sue only about one in 10,000 accounts assigned to them for collection.
The fact that collection agencies do not often sue people does not prevent them from threatening to sue debtors. It is very common for collection agencies, collectors employed by collection agencies, and lawyers sending letters to consumers on behalf of collection agencies to threaten legal action when, in fact, they have no intention of doing so.
Here are some other things you should know about collection agencies
- In many instances you can take action to stop collection calls from collection agencies—and in some instances creditors, debt buyers and law firms
- A creditor can only assign your outstanding account to one collection agency at any given point in time
- Creditors will often assign an outstanding account to one collection agency for several months and then recall an account and then assign it to another collection agency
- There are a handful of law firms in Canada that operate in virtually the same manner as a collection agency
- If your debt remains unpaid for more than six months then a collection agency representing your creditor (or its authorized collection agent) might be prepared to negotiate a one-time payment for less than one hundred per cent of the outstanding balance—and typically the older your account the more generous a creditor might be prepared to be
Your creditor might sue you if?
If you owe monies to your creditor then there is a chance that your creditor will sue you. If your creditor were to sue you then your creditor will incur significant costs to do so in terms of out-of-pocket expenses, labour, and administration costs. It is common for creditors to sue debtors and not to recover a penny from them. Consequently, your creditor will be much more inclined to sue you in circumstances where it is satisfied the odds are high that it will actually recover monies from you.
1. When might your creditor be inclined to sue you?
Your creditor might very well be inclined to sue you provided the following three conditions are satisfied:
- The dollar amount owing is not too small
- The relevant limitation period on the debt has not expired
- The debtor owns real property in his own name
Large creditors typically have a policy that they will not sue an outstanding account less than a specific dollar amount. There are few large creditors in Canada that will sue outstanding accounts where the outstanding balance is less than $4,000. This threshold for suing files might be significantly higher depending upon the creditor. Creditors are reluctant to sue consumers where the relevant limitation period has expired in connection with an outstanding account. If your creditor were to sue you where the limitation period has already expired and you filed a defence pleading the expiry of the relevant limitation period as a full and complete defence then your creditor will lose its lawsuit. Click here to learn more about limitation periods.
Creditors are much more likely to sue a debtor where the debtor owns real property—a house, townhouse, condo, cottage, farm, or rental property—in his own name. In this scenario, a creditor can sue a debtor, obtain a judgment against the debtor and place a lien on the debtor’s real property. The odds are good that when the debtor sells or refinances the property that the creditor will get paid. There is at least one major bank in Canada that will sue overdue accounts for as little as $5,000 provided the debtor owns real property in his own name.
2. When might your creditor not be inclined to sue you?
Creditors do not typically sue accounts in the following situations:
- Where the unpaid account is less than $4,000 or $5,000
- Where the account has been unpaid for less than six months
- Where the unpaid account has aged to the point where the relevant limitation period in the province where the debtor lives has expired on an unpaid account
- Where a collection agency is currently attempting to collect the account
- Where there is no reasonable likelihood that the creditor can recover monies from a consumer
- Where the creditor is not living in Canada
- Where the creditor cannot locate the debtor
To learn more about the likelihood of whether or not you might be sued click here to read a blog titled “Nine Reasons Why You Might Never Be Sued”
3. What will a creditor do when it intends to sue you?
Your creditor typically screens its inventory of unpaid accounts and separates them into one of two buckets. It will cherry pick those files it wishes to sue and these go into one bucket. The remaining files, which go into a much larger bucket, are the files which are assigned to one or more collection agencies for collection on a commission basis. In event that a creditor wants to sue an account then it might do one of the following:
- Use its in-house legal department to sue the file
- Farm out the lawsuit to one or more lawyers specializing in suing unpaid accounts
- Farm out the lawsuit to one or more paralegals specializing in suing unpaid accounts
Your creditor might sell your outstanding account
The creditor that originally provided you with goods, services, or credit can be described as your original creditor. It is possible for you to have a creditor who is not your original creditor. This can arise if your original creditor were to sell your outstanding account to another firm. In the event that your outstanding account is sold then the debt buyer steps into the shoes of your original creditor.
As a general rule, outstanding accounts which remain unpaid for less than six months are never sold. Furthermore, the major chartered banks in Canada rarely sell their outstanding accounts regardless of how long the accounts remain unpaid.
Where you owe monies to a creditor other than a bank the odds that your outstanding account will be sold typically increase as your account ages. A handful or creditors in Canada sell their accounts when they are only six months in default. The majority of accounts in Canada which are sold to a debt buyer, however, are more than three years old.
Unpaid consumer accounts are a commodity like fruit and the older the accounts the less they are worth. When a creditor sells debt that is more than three years old the debt might be sold for less than a penny on the dollar.
There are two categories of debt buyers:
- Collection agencies
- Debt purchasing firms
It is very common for collection agencies to purchase an inventory of overdue accounts. Collecting purchased debt, however, is a secondary business activity at collection agencies. The primary business of a collection agency is collecting outstanding accounts owing to others—and not purchased debt owned by the collection agency. There are also companies whose sole business activity is purchasing outstanding accounts. Unlike collection agencies, debt purchasing firms do not collect monies on behalf of other creditors. The company purchasing your debt—regardless of whether it is a collection agency or a debt buyer—has virtually the same options as your original creditor when it comes to what to do with your outstanding account. Debt purchasing firms might farm out their outstanding accounts to collection agencies for collection.
In some cases, debt purchasing firms might collect outstanding accounts using an in-house collection department. A debt buyer might also choose to sue you. You might be surprised to learn that in some instances—particularly where the limitation period on a debt has not expired–it might make more sense economically for a collection agency that has purchased your account to sue you than a collection agency that is collecting your account on a commission basis.
If a collection agency is collecting your account on commission then it only is entitled to a percentage of any monies recovered and the account will likely be recalled in a few months. In contrast if a collection agency were to purchase your account it might have only paid pennies on the dollar for it and it will keep one hundred percent of any monies recovered from the debtor. Furthermore, a debt buyer doesn’t have to worry about having an account recalled.
Your long-term options if you cannot pay your credit cards
If you are unable to make your credit card payments what are your options, in the long term, if you stop making payments on your credit cards.
1. Credit counselling
If you were to enroll in a Debt Management Plan with a non-profit credit counselling agency then you would repay hundred percent of your outstanding unsecured consumer debt in sixty monthly installments over a period of five years. In addition, you would pay a fee to the non-profit credit counselling agency, typically an amount equal to fifteen percent of each monthly payment.
2. Try to Negotiate settlements with your creditors
Once your outstanding account is more than six months outstanding it might be possible for you to negotiate a one-time lump sum payment to your creditor as settlement in full. There are two key factors which affect how generous a creditor might be in terms of a settlement. As a general rule, the older the debt, the more generous a creditor might inclined to be. Furthermore, a creditor might be more generous where there is little prospect that the debtor will ever be in a financial position again where he can repay the debt in full. [/accordion_panel] [accordion_panel title=”Do absolutely nothing”]A consumer might choose to do absolutely nothing in response to the fact that he is unable to make payments on his credit card. This might be the ideal option where it will very difficult for a creditor to successfully sue a debtor and then enforce a judgment against a creditor.
2. Consumer proposal
Under a consumer proposal a consumer meets with a Licensed Insolvency Trustee and the trustee makes a proposal to the consumer’s creditors. The creditors vote on whether or not to accept the proposal. Under the typical proposal a consumer repays thirty to forty percent of his outstanding unsecured debt by making monthly payments over five years. A consumer proposal becomes void if a consumer fails to make three consecutive monthly payments.
A consumer might choose to file for personal bankruptcy. Under bankruptcy a bankrupt surrenders all his non-exempt property to a Licensed Insolvency Trustee and this property is sold and distributed to the bankrupt’s creditors. Under bankruptcy virtually all debts owed by the bankrupt are discharged or forgiven except for government fines, monies owed for child support and spousal support, and civil judgments involving fraud. Where the bankrupt earns more than approximately $30,000 a year the bankrupt will have to pay a substantial portion of his wages to the Licensed Insolvency Trustee for several months.
4. Adopt a wait-and-see approach
This is a variation of the “do absolutely nothing” option. If you are unable to make payments on your credit cards and your creditors do not sue you then you will be able to avoid repaying this debt due to the expiry of a limitation period. A consumer who chooses to adopt the “wait-and-see” approach can always use another debt resolution option if he were to be sued.