As the worldwide COVID-19 pandemic rolls on, more than half of Canadians (53 per cent) are on the brink of insolvency — within $200 of defaulting on their bills — according to the 2021 MNP Ltd. Consumer Debt Index.
But what is insolvency anyway? Here we explain what insolvency means, how you can avoid it and how it’s different from declaring bankruptcy.
What is insolvency?
Insolvency is a financial state in which borrowers cannot pay their debts, or their debts total more than their assets.
There are two types of insolvency: consumer insolvency, which applies to individuals, and commercial insolvency, which applies to businesses.
Insolvency is not the same as bankruptcy. Bankruptcy is a legal process that discharges you from your unsecured debts, so you no longer have to pay them back. Insolvency is usually the state you are in before you declare bankruptcy. At this point, there are still many options available to you, including bankruptcy, to get out of debt and become solvent again.
If you still have assets that you could sell to pay off all your outstanding debts, you are not insolvent — even if a lack of cash flow means you cannot pay your debts on the day they are due.
The role of a licensed insolvency trustee
It’s common for a licensed bankruptcy and insolvency trustee (who must administer the distribution of non-exempt assets to creditors during the bankruptcy process) to do an insolvency test before recommending bankruptcy or another debt management solution to a client. This simple test determines whether you are insolvent based on the actual value (and not potentially inflated value) of your assets measured against your debts, or your after-tax income measured against your living expenses.
You are income insolvent if you don’t earn enough income to cover your living expenses, and if the actual total value of your combined assets can’t cover the combined amount you owe you are asset insolvent.
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What to do if you are insolvent
If you owe more than $1,000, your assets cannot cover your debts and you cannot pay your creditors when payments are due, you qualify for bankruptcy. It’s a legal process that can wipe the slate clean and allow you to start over financially, but you will need to give over the majority of your assets to creditors, and the bankruptcy will stay on your credit report for six or seven years. It can be expensive, especially if you have to make surplus income payments. A licensed bankruptcy and insolvency trustee must administer the bankruptcy.
A licensed bankruptcy and insolvency trustee also administers a consumer proposal. It is a legally binding lower monthly payment combining all your debts and agreed to by your creditors. The trustee negotiates with your creditors to reduce the amount of debt you have to pay and comes up with a set payment that you pay monthly for a maximum of five years.
Informal debt settlement
You may be able to negotiate with your creditors to settle your debt at a lower amount than you owe, especially if your debt is old and you’ve been paying it for a long time. Some creditors will agree to 50 per cent of what you owe or less.
Debt management plan
Reputable non-profit credit counsellors can negotiate a lower single payment for some of your unsecured debts, like credit cards. Then, you pay them for an agreed-upon period while they distribute the funds to your creditors. You must pay your debts in full with this route, but perhaps at a lower (or zero) interest rate. There is no debt forgiveness with this plan.
Debt consolidation loan
A debt consolidation loan allows you to combine credit card and bank debts into a single loan. This option may not cover all your debts but should cover at least some of them at an interest rate that’s lower than if you were to pay them straight up. It may not solve your entire debt problem, but it could help with a big chunk of it.