Dealing with overwhelming debt can be challenging, and one of the solutions available to Canadian consumers is a consumer proposal. This legally binding agreement between you and your creditors allows you to settle your debts by paying a portion of what you owe over an agreed period. While a consumer proposal offers a lifeline for those struggling with debt, it’s essential to understand how it affects your credit score.
In this blog, we will explain what a consumer proposal is, its impact on your credit score, and what steps you can take to rebuild your credit after filing one.
What is a Consumer Proposal?
A consumer proposal is a formal, legally binding agreement administered under the Bankruptcy and Insolvency Act (BIA). It allows you to negotiate a settlement with your creditors, where you typically pay a percentage of your outstanding debts over a set period—usually up to five years. Unlike bankruptcy, a consumer proposal allows you to retain your assets while providing some relief from debt obligations.
The key advantage of a consumer proposal is that it provides immediate protection from creditors. Once the proposal is filed, collection actions stop, including wage garnishments and harassing phone calls. It’s a more manageable alternative to bankruptcy, but it’s not without its consequences, particularly concerning your credit score.
How Does a Consumer Proposal Affect Your Credit Score?
Filing a consumer proposal has a significant impact on your credit score, but the extent of this impact varies depending on your financial situation before filing. Let’s break down the specific effects on your credit report and score.
1. Credit Rating Impact
When you file a consumer proposal, it is reflected in your credit report with a specific credit rating code. Credit reporting agencies like Equifax and TransUnion use a rating system from R1 to R9, with R1 being the best score and R9 indicating bankruptcy or bad debt.
A consumer proposal is typically given an R7 rating, which signifies that you have made an arrangement to pay a portion of your debts or are in a credit counselling program. This is a major blow to your creditworthiness and signals to lenders that you are a higher-risk borrower.
2. Duration of Impact
One of the most common concerns for individuals considering a consumer proposal is how long it will stay on their credit report. A consumer proposal remains on your credit report for three years after the completion of your proposal. If your proposal lasts five years, the total impact period could extend up to eight years. This extended duration can affect your ability to secure new credit or loans, as potential lenders may hesitate to offer favourable terms.
However, this duration is shorter compared to the effects of bankruptcy, which can stay on your credit report for up to seven years from the date of discharge.
3. Immediate Credit Score Drop
When you file a consumer proposal near you, you can expect an immediate drop in your credit score. Since the proposal indicates financial difficulty, your score can fall by several points, often bringing it to the “poor” category. The magnitude of this drop depends on your pre-existing credit score. Individuals with a high score before filing may see a more significant decline than those who already had a lower score due to missed payments or other financial challenges.
Rebuilding Your Credit After a Consumer Proposal
While the negative impact of a consumer proposal on your credit score is inevitable, it’s important to remember that it’s not a permanent situation. There are several steps you can take to rebuild your credit after filing the proposal and even during the repayment period.
1. Make Timely Payments
One of the most effective ways to rebuild your credit is to make all consumer proposal payments on time. These timely payments show creditors that you are taking responsibility for your debt and working to resolve your financial situation. Maintaining a consistent payment schedule is key to improving your creditworthiness.
2. Get a Secured Credit Card
A secured credit card is a great tool for rebuilding your credit after a consumer proposal. With a secured card, you provide a deposit that serves as your credit limit. Regular, on-time payments will be reported to credit bureaus, helping to improve your credit score over time. Just ensure that you use the card responsibly and pay off the balance each month to avoid accumulating more debt.
3. Monitor Your Credit Report
Keeping a close eye on your credit report is crucial while you work to rebuild your credit. Regularly reviewing your report will allow you to track your progress and ensure that the information listed is accurate. If you notice any errors or outdated information related to your consumer proposal, you can dispute them with the credit bureaus to ensure your report reflects your current financial standing.
4. Establish a Budget
After filing a consumer proposal, it’s essential to focus on managing your finances effectively to avoid future debt problems. Creating a realistic budget will help you track your income, expenses, and debt repayment progress. By staying within your financial limits and avoiding unnecessary expenses, you’ll be better equipped to rebuild your credit and regain control of your finances.
Conclusion
Filing a consumer proposal is a significant decision that provides relief from overwhelming debt while avoiding the more severe consequences of bankruptcy. However, it does come with a substantial impact on your credit score. The R7 rating and the duration of time it stays on your report can make it difficult to secure new credit, but with consistent effort, you can rebuild your financial standing.
By making timely payments, using tools like secured credit cards, and monitoring your credit report, you can gradually restore your credit score. While the road to financial recovery may seem daunting, a consumer proposal offers a structured pathway to a debt-free future.
