What is Insolvency

Ben: Hello and welcome to another Consolidated Credit webinar. Today we are gonna look at insolvency and what are your options when your monthly budget is in the red. So again we’re joined with Executive Director Jeffery Schwartz and he’s going to lend us his expertise, especially when it comes to the budget and what to do if you find yourself in a difficult situation. So thanks for joining us Jeff.

 

Jeff: It’s an absolute pleasure I just want to let everybody know insolvency is a tricky topic. The word is often thrown around without knowing really what it means as well many consumers think that’s all they can do without knowing what options they really have. Like I said, it gets tricky and getting help from an unbiased pro may be all that you need.

 

Ben: Okay so today we’re gonna look at exactly that what happens when you find yourself insolvent at the end of the month. So, before we do that, we’re gonna take a bit of time, like Jeff mentioned, just to define what insolvency is and what being insolvent means. After that, we’re gonna take some either take a look at some ways to determine if or how close to being insolvent you are, and finally what you can do to get some help if you always find yourself in the negative at the end of every month. After that we’re gonna have some time to take some burning insolvency questions. So let’s get started now.

Jeff that’s a scary statistic you see in the corner there so what does that statistic say to you about the financial situation of many Canadians? Why do you think so many Canadians are living close to the edge every month, just $200 away from being insolvent. What’s likely to happen if someone in that situation you know say if one of life’s many unexpected expenses pops up or something like that and they are living that close to the edge.

 

Jeff: Living on the edge is a reality for far too many Canadians. For me, it’s mostly about the lack of savings so let’s take a look at that firstly. Canadians today if they are saving, they’re only doing so at around 5%. Now let’s compare that to the 70’s and 80’s when that number was close to 20%. That means if you have an unexpected expense or a medical emergency or even reduction in your income from job loss or loss of hours, how are you going to come up with the money to pay your bill’s. The most common strategy, well just take on more debt. By the way it’s not just unexpected expenses its overspending. It’s taking on too much credit because it’s easy. It’s the rising cost of living with no increase in wages. All of these are examples that will set you back. Another approach to dealing with these issues would be to create a savings account that would be available for these unexpected expenses or reduction income until you get back on track. So, if you put away three to six months of expenses so that you don’t have to take on more debt just to get by. Look financial setbacks are gonna happen. You just need to be able to be prepared.

 

Ben: Right, so there’s just far too many Canadians who aren’t prepared for that. So you know some of them do find themselves up in an insolvent situation. So, I think it’s probably a good idea to start with clarifying what insolvency is or what being insolvent means to an individual because carrying debt doesn’t always equate to being insolvent. In fact, if there’s one thing I’ve noticed in the last three years or so doing this job is that Canadians are really good at servicing their debt now, not paying their debt they’re just servicing them. That means you know they make the minimum payments month after month maybe they pay late a couple days here and there but you know they never really feel like they’re getting ahead and that could be from you know the ease of access like you mentioned. It’s just easier to take on more debt than prepare for an emergency savings account. So, that’s a difficult situation to be in for sure but living in a high debt to income situation doesn’t necessarily mean that you’re insolvent but we’ll cover that more when we get to situations regarding debt to income ratios and what they mean later in the presentation. But for our purposes, insolvency simply means that you can’t pay your bills and monthly obligations when they’re due. There’s just not enough money, not enough income. So being insolvent can also happen when someone is upside down in their mortgage. You hear that term batted around once in a while so those are the examples of what’s called asset insolvency. Income insolvency just means that there isn’t enough cash to pay for your expenses and like Jeff mentioned, that often leads to taking on high interest credit to pay for the necessities. Asset insolvency on the other hand involves the things that you are paying off like mortgages, cars loan, investments, that sort of thing.

Jeff, I know you and Consolidated Credit have quite a bit of experience speaking to Canadians across the country that find themselves upside down in their mortgage. Can you just take a second to explain what that means – upside down – and how does some Canadians find themselves in that situation.

 

Jeff: Sure Ben, it’s really a sad situation especially when someone finds themselves upside down in their mortgage or their loan and what it really means is that the asset, the home, the car has negative equity. They owe more on the mortgage or loan than what the asset is actually worth if they were to try and sell it. It would actually cost them money to get out of it. So, here’s a quick example of a family that ran into this situation. Now remember, this is rare and in some of the major metropolitan areas be especially in the major metropolitan areas because the housing market has remained so strong and is still appreciating in value but what about the rest of the country. So back in 2008 – 2009 recession and particularly in southern Ontario, the car companies took a step backwards in areas like Oshawa and Windsor really got hit hard jobs were lost housing values tanked from their peak and families really suffered. So as an example, a family contacted us and was in the real jam. They purchased a house about two years earlier, financed it to about ninety percent of its value and then the housing market dropped. What’s worse is that the lender was pulling out of Canada and wasn’t interested in renewing so here’s the situation. The homeowner had paid off very little on their mortgage in the two years the house was now worth only 75% to 80% of its original purchase price and now the owner had to find a new lender. You do the math. The owner was going to have to come up with a big chunk of money to keep her house. She didn’t have those funds available to her, it was a real dilemma.

 

Ben: Wow, that’s more than just a dilemma you know I’d say that’s pretty scary stuff. You know with the Bank of Canada projected to leave rates alone or maybe even drop them is it really an issue of more peace being upside down in their mortgage. Do you see that you know becoming more common or maybe a repeat of 2008-2009.

 

Jeff: Well you’re gonna love my answer: yes no and maybe exactly especially when it comes to finances.  Ben, I mean with the number of people so close to the edge I think the study said $200 away from insolvency, it’s a real concern. So the answer yes. If interest rates went up then many people would feel that stress and put them over the insolvency edge. However this is more of a conversation of priorities and preparedness are people buying too much house with too little down. This is both a concern of priority and preparedness so not enough down payment results in too much house and too high a mortgage payment leaving less for savings and all their other expenses. If that’s the case, there are ways to avoid this and must be considered before even looking for a house. Before long or worse if something unexpected comes along insolvency may be just around the corner.

 

Ben: Right, some good points like I know it seems there’s a sense of urgency sometimes put on getting into the housing market but you’re saying you know maybe just spend a little while longer save a little bit more for that bigger down payment. It could help you later so kind of absolutely I think an absolutely .Ok well I’m gonna stick with my original statement then that’s still some pretty scary stuff so what are some ways to avoid the scary stuff. Well getting help as soon as possible is one of them. To do that you need to recognize the warning signs however and we see people that just either ignore the warning signs or they’re not sure that they’re actually there. So I kind of treat it as an illness. You know financial problems are kind of like a disease and what I mean by that is they’re often warning signs that appear first and if those warning signs are ignored or treated incorrectly then the disease is going to get worse. So, the warning signs of something like the flu might be a high fever, coughing but the warning signs of financial problems would be something like you know paying late, may be using one loan to pay off another loan, if your cards or limits are maxed out and they’re staying maxed out, you know that’s a pretty big indication that these things are not under control and just like with a bad case of the flu if you’re struggling to make your minimum payments every month then things are not gonna get better on their own. Eventually you’re going to need some help. Other serious warning signs of an impending debt crisis would be, you know if collectors are calling, you’re being denied loans from the banks and traditional lenders. That’s not only going to damage your credit score, but they also make financial stress even worse. You know being denied loans from traditional lenders often sends people to high interest or alternative lenders. Those types of lenders offer loans that might help for a little while you know keep up bill payments buy some groceries that sort of thing but often they wind up making a tough situation even worse and the longer they go on the worse it gets. It’s kind of like trying to treat, you know the seasonal flu, with cough syrup. Sure it might help with the cough but the flu is what making is making you sick so you need to treat the root cause so that’s kind of where we’re going to take the rest of the webinar.

Now so like we mentioned earlier you can carry debt and not technically be insolvent. One doesn’t necessarily mean the other. Isn’t there is certain in fact managing good debt like a mortgage or a student loan is actually a really good thing for your credit score but credit score is not the be-all end-all of financial security. There are people out there with good credit scores that go bankrupt. So how do you know if you’re in the state of being insolvent. Well Jeff what would you say is a simple way to tell whether or not someone is insolvent.

 

Jeff: That’s a good question because that comes up and again. It’s around the definition of insolvency. So, this is something that our counsellors see every day is the clients insolvent or do they just have a high debt level they need to get under control. It’s also worth noting that just because something is simple doesn’t mean it’s going to be easy, so to answer your question something simple that you can do to determine whether or not you’re insolvent is to make a budget. There are so many tools and resources even some great apps that are out there you can even use a pencil and paper old-school style but the first thing you need to be sure of is how much you make. This will include your regular income as well as any irregular income and by irregular income I mean things like tax refunds, benefits, bonuses, gifts, inheritances, and annuities. That kind of stuff. So how much do you earn each month, once you figure it out how much you earn you can start to look at how much you spent. Just like with your income, some expenses are regular ones like rent or car payments, other expenses could be irregular or flexible such as vehicle maintenance or utilities. Once you figure out how much you make and how much you spend, you can use some simple math to determine if your budget is in the positive or the negative. If you’re in the negative, you’re probably going to need to get some help and getting it sooner rather than later can literally save you thousands of dollars.

 

Ben: Right and like you said, it’s just simple math simple subtraction. There is a great way to kind of determine whether you’re in a state of being insolvent. So this is something I know I hear a lot in my workshops you know how much is too much debt how much debt can I carry and still maintain you know my lifestyle so just like in our last slide, all you’re going to need to do is some basic, you know grade five math to find out if you’re carrying too much debt. So, for that I’m talking about the debt to income ratio. Determining that is a really easy way to help you decide how manageable your debts are and how much help you’re going to need to get out of debt. To determine the debt to income ratio you’ll need to add up all of your monthly debt payments so credit cards, lines of credit, car loans, student loans … All of it added up. The total amount of your debts payments each month and then you’re going to divide that by the amount of your take-home pay. So, you know if I had a thousand dollars of debt payments due each month and I made four thousand dollars every month I’d have a twenty five percent debt to income ratio. But what does that mean? Well once you figure out your debt to income ratio if you find that you’re under 30 percent then you can probably manage. I mean there’s work to do you want to focus on paying down your debt, being debt-free trying to free up some of that cash for other financial goals however if you find yourself between maybe 30% to 50%, then you could be in a tight situation. And it might get worse especially if an unplanned expense comes up or you know like Jeff mentioned, lead to overspending or taking on additional credit and we see people like that in a tight situation usually they only might be juggling bills maybe they’re paying late or they just have an extremely low cash flow. Money’s really tight at the end of every month. So people who find themselves with a higher than fifty percent debt to income ratio, I’d say they’re pretty much working for their creditors at that point. It means that more than half of their take-home pay is going towards servicing their debts and we often see people in this situation with multiple accounts and collections which adds to their financial stress and they might have even received a notice of legal action for an outstanding debt. So, if you’re in this situation, not only are you technically insolvent but you’re also in need of immediate financial assistance. So, you know people often ask me do I need to go bankrupt? You know what level of insolvency do I need? What about a consumer proposal? That sort of thing so like I said the two aren’t mutually agreed. Right if you’re insolvent, you might not have to go bankrupt so some options to look at include the legal ones like bankruptcy and consumer proposal but these are drastic measures and they have severe consequences so a good way to look at bankruptcy is you know it’s the last resort and it should be treated as such. If you have the option to file a consumer proposal then that’s probably the avenue should you should explore but you’re going to need to enlist the help of a licensed insolvency trustee to see the matter through court and ensure that the laws and the insolvency regulations are followed. So, you can check out our video all about consumer proposals and bankruptcies where we actually sat down with a trustee and explore the differences between the two. But today, I think it’s safe to say that a consumer proposal is often seen as the better option for both the consumer and the lender. But now, depending on your level of indebtedness and your current debt to income ratio, there might be other debt relief options you want to explore that you might not even know exist. So Jeff since you’re the debt expert perhaps you can just take us through the role of a credit counsellor and the various options for those looking to get out of debt but maybe that want to avoid insolvency or the bankruptcy process.

 

Jeff: Okay sure thing Ben and you’re right, bankruptcy and consumer proposals have serious consequences and if it’s possible to avoid them then it’s in the debtors best interest to at least look at other options and that’s where a credit counsellor comes in and their job is about clarifying your financial situation and offering solutions to get you out of debt. Some options a consumer may consider to avoid filing and insolvency if they can are altering their budget and reduce spending or increase the amount of their income to get them back on track. Getting help to pay down their debt from friends or family. I know that can be a bit of a hit to your ego but at the same time it’s probably going to be the least costly way to do it or a consolidation program and consolidation programs have a few different options. One that you may hear marketed it all the time online or on TV or the radio is a balance transfer on the credit card. Another one is a consolidation loan. One is a home equity loan and another one that we use quite frequently at Consolidated Credit is a debt management program. Okay and the problem with many of these is that with the exception of the debt management program, they’re only going to work if you have a good credit profile and by the time many seek help it’s too late. However, even if you do have a good credit rating there are limitations on all of them. Whether it’s putting up collateral and putting that at risk or low interest rates for too short a period to pay it all back. So there’s another reason to speak with a trained credit counsellor to go over all these options and find one that works best for you.

Ben: Right so just talking to someone clarifying your situation you might discover an option that you didn’t know existed.

 

Jeff: Exactly.

 

Ben: What can I do or what can you do well. I mean obviously doing nothing is the popular choice but I’m gonna say that’s the wrong one at the first sign of debt problems, I always advocate reaching out to your lenders directly. Let them know your situation whether you were laid off or you’re going through a divorce and see if there’s a hardship program you can apply for. You might not want to go bankrupt but trust me your creditors really don’t want you to go bankrupt, so often they’re gonna work directly with you to set up an arrangement or an affordable payment plan and try and keep you from getting into a worse situation but if that’s not gonna work then like Jeff said, I would speak to a nonprofit credit counsellor. Speaking to them there’s no charge right so you’re gonna walk through a budget assessment you’re going to do a debt assessment and like we’ve said they’re gonna help clarify your situation. It’s free and if it turns out at the end of assessment you are in fact insolvent then they’ll get you in touch with the right financial professional who’s going to help you with the next step of the process. Often that next step involves the help of a licensed insolvency trustee. They’re going to be able to assess your situation and determine if going bankrupt is the right course of action. Like I mentioned earlier, if a consumer proposal looks like the better option then they’ll explain the process to you and can help you set up the payments. You’ll typically see a reduction in the amount of the debt usually about one-third of what you owe so let’s say for instance you owed about sixty thousand dollars in debt. Through a consumer proposal you could expect to pay about twenty thousand dollars over a five-year term. Well, like we mentioned earlier these are legal processes they have long lasting consequences, so it definitely takes some time to determine which one is the best solution for you. So, we’ve got a little bit of time left over we can cover a few of the frequently asked questions that we get. So, the first one we have here is “should I include my tax debt in my debt to income ratio and can tax debts be included in a bankruptcy?” I’m gonna say yes. You know most tax debts can be included in a bankruptcy and yes you should certainly include those tax debts in your debt to income ratio. It’s eating up a portion of your monthly income, so you want to make sure that it’s in there.  You’ll also want to act right away if you owe the CRA money. They have powers to collect that other collectors don’t have. They can do direct bank garnishment, so you know if that’s the type of debt you have you really want to take care of it quickly. The next question looks like it’s gonna be a good one for Jeff to take and I hear it quite regularly “can a collection agency seize my property?”

 

Jeff: That’s a tough one and as it’s different and one of the reasons why is because it’s different case-by-case but ultimately, I would say yes. In general, to  property of collection agency must have a court order allowing it to do so and it’s definitely not as easy as it sounds and by the way, they don’t want to do that either unless they believe you have goods with enough resale value to cover the amount that you owe. They may not want to spend the effort and cost and legal fees to do this so if there’s significant equity in the asset a home for instance then yes, the risk of it being seized is real.

 

Ben: All right so you know, thanks for listening. If you have any other questions, please feel free to send it to the email below at consolidated credit. They’re happy to answer your questions. You’re going to contact you if that’s what you want to do the other thing that we would like to mention is if you’re looking for some continued education you can use the “kofe” platform if you’re interested in learning about how the knowledge of financial education platform can help you or your organization with financial stress. So please feel free to reach out to me. I’d love to set up a free demo for you if you’re interested in that and I’d also like to thank Jeff for taking time out of his day to help us kind of clarify a difficult situation.