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Debt Consultants and Debt Management Plans: Scams, or a Good Alternative to Bankruptcy in Canada?

Debt consultants and for profit credit counsellors have become very aggressive over the last few years. In some cases they may be able to help you get out of debt, but in most cases they can’t do anything for you that you can’t do for yourself. Here’s how they work:

They run big advertisements in the newspaper promising to reduce your credit card and other debt by up to 70%. Debt relief sounds great, so you start making monthly payments to them, and they promise to use that money to negotiate a debt settlement with our creditors. I’ve met with many people over the years who assumed that the money they were paying each month was being distributed to the creditors, but that’s not how it works. What’s actually happening is your money is building up in the debt consultant’s bank account, and when they have enough money to propose a settlement, they make the deal with your creditors. Here’s an example:

Joe and Mary owe $30,000 on five credit cards. The debt settlement company promises to settle all of their debts for $20,000, with no further interest. Joe and Mary think that’s a great deal, because if they were to pay off their debts on their own, with interest, it would cost much more than $30,000. They agree to pay $400 per month for 50 months to the debt consultant.

The debt consultant can negotiate a lump sum settlement with the credit card companies, but they can only do it once they have a lump sum of money. The first ten payments Joe and Mary make go directly to the debt consultant for their fees. Once their fees are paid, the money builds up in the consultant’s bank account until they have approximately 40 cents on the dollar to make the settlement. If Joe and Mary owe $10,000 on one of their credit cards, the consultant will wait until they have $4,000, and then approach the credit card company with the settlement offer.

What’s wrong with this strategy? Why are these deals in most cases nothing more than a scam?

First, if the debt consultant wants the first 10 monthly payments for their fee, and then wants another 10 payments for the settlement offer to the first credit card company, it will be 20 months before the first credit card company gets any money. It is unlikely that a lender will sit around and wait for 20 months to get their money. In most cases they will continue to call you, and perhaps even sue you, to get their money.

Second, debt settlements will not work on all types of debts. The government will not accept 40 cents on the dollar, paid 20 months from now, to discharge your tax debt. Credit card companies may accept a plan, but governments won’t.

Third, the debt consultant has no way to force all creditors to agree. He may get one or two of your credit card companies to agree to a deal, but if the others don’t agree and sue you, the deal will fall apart. You need relief for all of your debts, not just some of them.

Fourth, in many cases the debt consultant is not doing anything that you couldn’t do on your own. Accumulating money in a bank account for two years, and then sending it to the credit card company does not take a lot of professional expertise. If you want to wait two years and then make settlements on your debts, you can do it on your own.

Fifth, many debt consultants will meet with you, review your situation, charge you a fee, and then refer you to a bankruptcy trustee or consumer proposal administrator! They don’t actually do anything for you, other than provide an opinion that you need to see a trustee. I’m a big believer in getting a second opinion, but since a trustee or consumer proposal administrator will NOT charge you for an initial consultation, you should start with a free initial consultation, and then get a second opinion if you are not satisfied.

Finally, in most cases debt consultants do all of their work over the phone. That keeps their costs down, but it also means you never get to meet them. Do you really want to turn over your hard earned money to someone you will never meet in person?

Many of you who are reading this will probably be thinking that I am exaggerating the pitfalls of debt settlement. After all, I’m a trustee in bankruptcy, so I’m biased. It’s natural to assume that I think bankruptcy in Canada is the solution to your problems, not debt settlement, because that’s what I do for a living. Fair enough, but let me give you two actual examples. Here are the stories of two people I met with on one day last week. These are not unusual stories. I did not need to go looking through my files to find examples. I personally met with both of these people last week, and I have met with hundreds of other people with the same story. (I have changed the names of the people to protect their privacy).

Case #1: John Smith entered into a debt management plan with a well know debt management company eleven months ago to deal with $27,000 worth of debt, because he wanted to avoid bankruptcy. He has been paying $300 per month for the last eleven months, to deal with his three credit card debts. Two of the credit cards have not bothered him, but one of credit cards, from Bank X, took him to court three months ago and obtained a garnishment order against him. Starting next week they will be in a position to garnishee his wages. When he met with me last week I reviewed his situation, and based on his income he has decided to file a consumer proposal. With the consumer proposal he will be paying $300 per month, and he will be paying for a shorter time period than was proposed under his debt management plan.

Key Message: The lesson here is that a debt management plan is not binding on all creditors, so even though he has paid $300 per month for a year, he has nothing to show for it. If one creditor doesn’t agree, they can garnishee his wages, making it impossible for him to continue with the plan. He will file a proposal, for $300 per month, and had he done that originally he would already have paid for a year, instead of starting over.

A consumer proposal, once accepted by a majority of the creditors, is legally binding on all unsecured creditors. A debt management plan isn’t.

Here’s the second story:

Case #2: Joyce and her husband Fred started a debt management plan with a company for $2,000 per month for 42 months, or $84,000 in total. Their total debts are $70,000, so they are paying $14,000 in fees and interest, since one of their creditors did not agree to a reduced rate of interest during the plan. When I met with them I calculated that based on their income a consumer proposal would cost approximately $800 per month for 50 months, or about half the cost of the debt management plan. The consultant did not explain to them how much they were paying in fees, and they did not realize that one of the creditors, a large bank, is still charging them interest, so they are not getting a deal; they could have negotiated to pay the full amount owing with interest on their own. They have paid for three months in the debt management plan, but they will now stop it and file a consumer proposal.

Key Message: The lesson here is don’t agree to anything unless you fully understand what you are agreeing to.

If all the consultant is doing is charging a fee and then sending the money to your creditors, they aren’t really providing much of a service. You can do that on your own.

Does this mean that all debt settlement companies are bad? Are they all scams?

I have not researched every company in Canada, so I will not make any general statements about all companies. I will tell you this: do your own research. Ask questions. Here are some good questions to ask:

  • Do I get to meet with anyone in person? If not, where are you located? Are you in my city?
  • Are you licensed by the federal government? What professional qualifications do you have?
  • What is the total cost of the service?
  • When will creditors start receiving money? Does the consultant get paid before the creditors get paid?
  • Will all creditors agree to the deal? What can I do if one of them doesn’t agree? Can they still sue me?
  • What will this do to my credit report?

If you are comfortable with the answers you receive, then you can make the decision to hire a debt settlement firm to deal with your debts.

There are cases where debt settlement is the correct solution, such as when you have a small amount of debts, or you have access to a lump sum of money for the settlement, or you are not insolvent. There are lawyers, that are regulated by the government, that can act on your behalf.

However, in most cases if you want to avoid bankruptcy, and you have the ability to make payments each month, a better option is a consumer proposal. In a consumer proposal all unsecured creditors vote on your proposal, and if a majority of the dollar value of your creditors accept it, it is legally binding on everyone. That means you won’t have the same problem that John Smith had, where two creditors agreed and one didn’t, and that one dissenting creditor sued him.

All consumer proposal administrators are licensed by the federal government, and they will all meet with you in person. The cost of a consumer proposal is set by the federal government, so all fees are standard regardless of which consumer proposal administrator you use, and all fees will be explained to you in advance. (All fees are included in your monthly payment; there are no extra charges). Unlike with some debt settlement companies, a consumer proposal administrator receives most of their fees when the creditors get paid, so everyone is working to make the proposal work. A consumer proposal, credit counselling and debt settlement all appear as negotiated settlements on your credit report.

You have options. You can avoid bankruptcy, but you must do your research, and make an informed decision.

3 Responses to “Debt Consultants and Debt Management Plans: Scams, or a Good Alternative to Bankruptcy in Canada?”

Fred Smith said...

“A consumer proposal, credit counselling and debt settlement all appear as negotiated settlements on your credit report.”

really?? So why does it say on this very same site that:

“As soon as you file a consumer proposal, your credit rating will be revised to either an R7 or an R9 and it will probably remain at this rating until the proposal is completed.
After you complete your proposal payments, a note indicating you have filed a consumer proposal will appear in your credit record, typically for three more years. That means that your consumer proposal affects your credit record for up to eight years from the date that you filed the proposal to creditors, depending on the length of your payment period.
For example, if you make a proposal where you are making monthly payments for three years, the proposal remains on your credit report for a total of six years.”

It seems like you conveniently left that part out…

ronald nash said...

Your web site is excellent the best I have seen.

I followed a bus the other day and was struck by the ad on the back “settle 75% of your debts without bankruptcy”. Even if one was able to make an accepted consumer proposal I understand your credit report would show a rate 9, same as bankruptcy for 6 years.

Some debt consultants ignore residential equity to re-mortgage, because no $4,000 is made by them. Although some get that up front before any re-mortgage is carried through or passing to a compliant trustee for a consumer proposal.

I am a 78 yr old semi retired accountant and knew quite a number of large CA trustees and am more familiar with troubled corporations than consumers. Nevertheless I am appalled by the prolific numbers of these “debt consultants”. The stories I have heard of their fees are disgusting. One apparently charged $2,000 then because equity allowed for a re-mortgage a further $6,000 hen another $10,000 for past services. Even when the debtor was approached the individuals remained unfazed. It appears the debtor was instructed not to discuss any arrangement especially with a lawyer.

You have to wonder how gullibile or ignorant are consumers. Finally in the States the written off debts are included by the IRS as income so income tax can be charged!

Debra Stark said...

My ex husband and I went to a Company who paid our debt back monthly CCSO (Ontario), what they DONT tell you (incuding the fella on here) is BOTH options are as good as bankruptcy on your credit report!! He could not get credit for 7 years (and we paid $1800 per month) and he made over $100,000 per year, this is VERY important-would you rather have the $1800 to live on? or would you rather claim bankruptcy (clear yourself of the hassle) and keep your income to survive. I know if i had the choice to make again it would be the later…that 1800 KILLED us monthly to scrape up(4 years long) and we couldnt get credit to save our lives..with 2 kids and a crap car we sometimes didnt eat(meanwhile (if we knew we were screwed for 7 years no matter what-Bankruptcy would have beent he way to go. At least your slate is wiped off and you keep that money in your pocket every month( face it-if your behind-chances are your survival is usually at stake-so that money going out isnt helping anyone but the fat cats:) Just my 2 cents..and the credit card companies (unbeknowst to many people sometimes desguise different companies to COLLECT for them (that’s why all a sudden you’ll get a 1/2 decent interest rate and tons of time to pay it back…they figure something is better than nothing and using their resources to track you.. Just some food for thought..last card companies (in addition to the high interest rates) SELL your debt to a collection agency for a percentage of what you owe(then they write off the rest through insurance(which they are required to have in order to lend). So not only do they get your high interest over the many months b4 you fell behind , money the collections pays to “buy” your debt and the “write off” amount from their insurance, they also try to take your self esteem with snitty collectors (who never know what to say to the above BTW:)… (they are laughing all the way to the bank).. I say…think about yourself.. no-one else will.