Consumer Debt Relief in the United States and Canada

HYG-5247
Family and Consumer Sciences
Date: 
09/09/2019
Cäzilia Loibl, associate professor and Extension state specialist

In July, the New York Fed’s “Quarterly Report on Household Debt and Credit” reported that delinquency rates on mortgages, auto loans, and credit cards are currently similar to, or lower than, they’ve been at any point since 2000. Serious delinquency (90 plus days) for all loan types, except for student loans, which remains high, peaked during the Great Recession and are currently low or very low compared with historical levels (Federal Reserve Bank of New York 2017a, b).     Illustration of a sad man with a large debt belly and a briefcase

As a result, the number of consumer bankruptcy filings in the United States is low. In 2016/2017, about 770,000 U.S. consumers filed non-business or consumer bankruptcy, plus 23,000 businesses. In contrast, during the peak of the Great Recession, over 1.5 million non-business, consumer bankruptcy filings were recorded (United States Courts 2017).     

In the United States, 1 in 8 consumers is likely to file for bankruptcy in a lifetime (Addo 2017). In the U.S. bankruptcy legal system, consumer bankruptcy is considered a safety net that offers consumers a “fresh start” and initiates protection from creditors, in addition to providing an equitable distribution to creditors (Landry III 2016).     

Consumers can choose between two very different sets of legislation when filing for bankruptcy: Chapter 7, debt liquidation, or Chapter 13, debt reorganization. Similar to Canada, as described below, U.S. consumers have the option of entering a debt management plan to avoid filing for bankruptcy.

Bankruptcy Code Chapter 7

Chapter 7 is the common choice, and in the past year, about 489,000 U.S. consumers filed under this legislation (63% of non-business filings). Filers with little or no financial assets (or the assets they own are exempt from liquidation, such as a car), unstable incomes, and/or a larger portion of unsecured debt will be more likely to file Chapter 7. Chapter 7 filers work primarily with court appointed trustees. They rarely meet with judges, use lawyers for representation, and require minimal court involvement. The entire process takes an average of four months (Addo 2017, Gerdano and Flynn 2016).

Bankruptcy Code Chapter 13

Close to 300,000 U.S. consumers filed under Chapter 13 in the year ending June 30, 2017 (38% of non-business filings). This choice is attractive to filers who have regular income and would like to keep their non-exempt assets. For example, most homeowners declare Chapter 13 bankruptcy in order to become current on mortgage payments and prevent losing their homes to foreclosure. Debtors commit to paying down a portion of the debt based on a repayment plan agreed to with the courts and a bankruptcy trustee. Repayments are collected and distributed to creditors. Remaining debt is discharged after the repayment plan is completed. More than half of debtors fail to adhere to the repayment plan; their cases are dismissed or converted to Chapter 7. Chapter 13 bankruptcy has a high level of court involvement, higher attorney fees, and lasts an average of three to five years (Addo 2017, Gerdano and Flynn 2016).

Bankruptcy Code Chapters 11 and 12

Chapter 11 is for business reorganization and applies to certain wealthy individuals and Chapter 12, reorganization of family farmers and fishermen. The filings under these two chapters comprise about 3% of non-business consumer filings (Gerdano and Flynn 2016).

Bankruptcy ReformBankruptcy papers

The past decade has seen two major changes: the 2005 reform of personal bankruptcy through the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 (BAPCPA) and a mortgage-relief measure aimed at reducing foreclosures enacted in 2009, the Home Affordable Refinance Program (HARP) (Mitman 2016).     

The goal of BAPCPA was to shift consumers from Chapter 7 to Chapter 13. It required a means test that prevents individuals with incomes above the applicable state median income from filing under Chapter 7 and requires them to repay some or all of their debts within a repayment plan (Landry III 2016). Because Chapter 13 is a more lengthy and expensive process, it has prevented an estimated 6 million U.S. consumers from filing bankruptcy within a decade of enactment (Gerdano and Flynn 2016).   

HARP provides financial information to U.S. homeowners at risk of default to refinance their homes. It reduced the number of bankruptcy filings among homeowners whose mortgages are larger than the market value of their homes by about 3 million (Federal Housing Finance Agency 2017). The program is available to homeowners with a loan-to-value ratio of greater than 80% and who are current on their mortgage payments. The primary expectation for Home Affordable Refinance is that refinancing will reduce monthly principal and interest payments, reduce the interest rate, reduce the amortization period, or move them from a more risky loan structure (such as an interest-only mortgage or a short-term ARM) to a more stable product, such as a fixed-rate mortgage. HARP ended on December 31, 2018 (Fannie Mae 2017).

Resources on how to get started with managing debt and applying for bankruptcy:

Federal Trade Commission: “Filing for bankruptcy: What to know” consumer.ftc.gov/articles/0224-filing-bankruptcy-what-know

U.S. Department of Justice: “Consumer information” justice.gov/ust/consumer-information and “Credit counseling and debtor information” justice.gov/ust/credit-counseling-debtor-education-information

National Consumer Law Center: “For consumers” nclc.org/for-consumers/for-consumers.html

Consumer Debt Relief in CanadaPhoto of a man holding an empty wallet open.

Consumer debt in Canada is at near-record highs. Statistics Canada (2017) reports that the ratio of debt-to-disposable income is 166.9% meaning that Canadians owe C$1.67 for every dollar of disposable income. The Bank of Canada warns borrowers that interest rates will eventually increase from near record lows. A major concern is that rising consumer debt levels, interest rate hikes, and an unbalanced housing market will leave Canadian households vulnerable.

When Canadians are struggling with debt, they have three options: They can file for bankruptcy; file for a consumer proposal; or seek debt counseling and enter into a debt management plan. Each of these options has different implications for the consumer as well as the financial institutions that have extended them credit.

The Government of Canada, under the Bankruptcy and Insolvency Act, regulates bankruptcy and consumer proposal options. In both cases, a federally licensed Trustee must act on behalf of the consumer and the creditors to formulate an acceptable solution. Debt management plans are available through not-for-profit credit counseling agencies that are registered charities across Canada. Debt management plans are not regulated. Although all three programs offer debt relief, there are significant differences between the options and those differences can be difficult to understand let alone be able to confidently compare for consumers. Under each scenario, the consumer is granted some relief from their debt.

Bankruptcy

Bankruptcy is a legal process that can provide relief to individuals who are unable to pay their debts. Bankruptcy typically takes approximately nine months to complete, and in some cases, consumers filing bankruptcy can have their debt forgiven completely. The filing of an assignment in bankruptcy immediately stays any legal action by creditors with certain exemptions. This may be an advantage to consumers who have been experiencing wage garnishment, for example. In some cases, the debtor will have assets taken and applied towards the outstanding debt. Those filing bankruptcy get out of debt more quickly but their credit will receive an R9 rating, which is the lowest credit rating. Depending on the providence of residence, the negative impact on a credit score can last for six to seven years. Bankruptcies and consumer proposals totaled over 125,000 in the 12 months ending December 2016; an increase of 3.5% over the previous year. Approximately half of these were bankruptcies (Government of Canada 2016).

Consumer Proposals

A consumer proposal is also a legal process for debt relief. It provides the debtor with an opportunity to make a settlement with creditors by extending the repayment period or reducing the amount to be paid. Consumers entering into a consumer proposal will negotiate their debt with their lenders and generally end up paying some portion of their debt back. Consumer proposals take approximately 18 to 36 months to complete, up to a maximum of five years. Consumers entering into a consumer proposal plan receive a rating of R7 on their credit reports, a slightly higher rating than those who filed bankruptcy. There has been a significant increase in the number of proposals filed because of legislative reforms in 2009 to the Bankruptcy and Insolvency Act (BIA). Consumer proposals constituted 17.4% of insolvencies in 2007 and grew to approximately 50% in 2016 (Government of Canada 2017).

Debt Management PlansImage of a woman working with a a debt management company to manage her debt.

Debt repayment programs are similar to consumer proposals but they are a voluntary payment of 100% of the debt owing over a longer timeframe. Usually only unsecured debt is covered, though occasionally secured debt is included. Consumers entering into a debt management plan typically take longer to pay off the principal owing, using the full maximum five-year period to complete. The credit counseling agencies negotiate with lenders on the consumers’ behalf to negotiate lower interests and repayment periods.

Consumers entering into a debt management plan also receive a rating of R7 on their credit reports. Statistics from 2012 to 2016 from Credit Counselling Canada show an increase in the number of new counselling cases (26%) and new debt repayment programs (20%) (Credit Counselling Canada 2017). Currently over 14,000 individuals and families are using a debt repayment program to repay their debts; over $83 million was paid back to creditors last year (ending March 2016).

Resources on how to get started with managing debt and applying for bankruptcy:

Office of the Supervisor of Bankruptcy: “You owe money” ic.gc.ca/eic/site/bsf-osb.nsf/eng/h_br01854.html

Government of Canada: “Managing Debt” canada.ca/en/financial-consumer-agency/services/debt.html

Government of Canada, Justice Laws Website: “Bankruptcy and Insolvency Act (R.S.C., 1985, c. B-3)” laws-lois.justice.gc.ca/eng/acts/B-3

Credit Counseling Society: “Debt Repayment & Bankruptcy Solutions—Credit Counselling for Canadians” nomoredebts.org/debt-help/debt-repayment-and-bankruptcy-solutions.html

References

Addo, Fenaba R. 2017. “Seeking relief: Bankruptcy and health outcomes of adult women.” SSM—Population Health, 3:326-334.

Credit Counselling Canada. 2017. Our reach. Toronto, Canada.

Fannie Mae. 2017. Home Affordable Refinance Frequently Asked Questions, (August 17). Washington, D.C.

Federal Housing Finance Agency. 2017. Home Affordable Refinance Program (HARP®), Policy, Programs & Research. Washington, D.C.

Federal Reserve Bank of New York. 2017a. "Household debt surpasses its peak reached during the recession in 2008." In Press Releases (May 17). New York, N.Y.

Federal Reserve Bank of New York. 2017b. Quarterly report on household debt and credit, Quarter 2 (August). New York: Research and Statistics Group, Microeconomic Studies.

Gerdano, Samuel J., and Ed Flynn. 2016. “The rollercoaster effect: Will bankruptcies tick up in 2016 after the 2015 decline?” ABF Journal (March):n.p.

Government of Canada. 2016. Insolvency statistics in Canada. Ottawa: Innovation, Science and Economic Development Canada, Office of the Superintendent of Bankruptcy Canada.

Government of Canada. 2017. Annual consumer insolvency rates by province and economic region, (2010-2016). Ottawa: Innovation, Science and Economic Development Canada, Office of the Superintendent of Bankruptcy Canada.

Landry III, Robert J. 2016. “Ten years after consumer bankruptcy reform in the United States: A decade of diminishing hope and fairness.” The Catholic University Law Review, 65 (4):693-711.

Mitman, Kurt. 2016. “Macroeconomic effects of bankruptcy and foreclosure policies.” American Economic Review 106 (8):2219-2255.

Statistics Canada. 2017. National balance sheet and financial flow accounts, first quarter 2017, (2017-06-14). Ottawa, Canada.

United States Courts. 2017. June 2017 bankruptcy filings down 2.8 percent, Judiciary News (July 21). Washington, D.C.