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What Affects Your Credit Score More: Debt Settlement or Bankruptcy?

Aaron Broverman

Nov 20, 2021 8 min read

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How debt settlment and bankruptcy each impact your credit
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    If you’re in the unfortunate position of having to contemplate a debt settlement or bankruptcy, the number one question you probably have is: which one will affect my credit score more? In other words, which is the lesser of two evils?

    Both a debt settlement and a bankruptcy negatively affect your credit score, but the impact they each have is slightly different. Bankruptcy lowers your credit score more drastically in the short-term, sometimes as much as 200 points or more. Debt settlement decreases your credit score between 75 and 100 points, which isn’t quite as steep as a bankruptcy, but may keep affecting your credit in the long-term depending on how the settlement is listed on your credit report.

    Each option has nuances and details that you should consider. If you’re contemplating which option is the best for you and your long-term financial health, keep reading to learn more.

    What's The Impact of Debt Settlement and Bankruptcy on Your Credit?

    Declaring bankruptcy is a legal process governed by Canada’s Bankruptcy and Insolvency Act and managed by a bankruptcy and insolvency trustee who organizes any of your eligible assets and any surplus income into a trust to distribute among your creditors. A bankruptcy remains on your credit report for an average of six years after you file. The number of years that information stays on your credit report depends on which province you live in. 

    A debt settlement, on the other hand, is an informal arrangement you can make with one or more creditors to pay less than what you owe with lower monthly payments.

    However, unlike bankruptcy, your creditors don’t have to agree to debt settlement and they won’t perform debt settlements unless your account is already delinquent. This means that your credit can be damaged for much longer.

    To gain more information, Borrowell spoke with Doug Hoyes, licensed bankruptcy and insolvency trustee and co-founder of Hoyes Machalos. Here’s what he had to say about how bankruptcy and debt settlement appear on your credit report (and how to read your credit report).

    “In the short term, a bankruptcy will appear on your credit report as an R9, which is a write-off. A debt settlement, in the form of an informal debt settlement, a debt management plan, or a consumer proposal, will appear as an R7, which is a settlement plan. An R9 is more impactful than an R7, so a bankruptcy has the most immediate negative impact. 

    However, with a bankruptcy, your debts can be discharged [eliminated] in as short a time period as nine months, at which point you can begin to save money and rebuild your credit.  With a debt settlement program, your payments may last for up to five years, so the long term implications on your credit will depend on the amount you are required to pay in each option.”  

    What are The Advantages and Disadvantages of Bankruptcy?

    Here are some of the main advantages and disadvantages of filing for bankruptcy.

    Advantages of Bankruptcy:

    • It provides a clean slate from which to start your finances over

    • As soon as you file, all collection calls, threats of legal action and wage garnishment legally must stop

    • You will not have to pay back all your debts in full

    • Most debts, including credit card debt, bank loans, payday loans, student loans and all personal tax debt owed to the Canada Revenue Agency (unless the CRA has placed a lien on your property) will be forgiven

    • The process is legally binding, so it’s governed by the rules set out by the Bankruptcy and Insolvency Act of Canada, which makes it safe and predictable for all parties involved

    • You can potentially be discharged from a first bankruptcy after nine months.

    • You won’t lose everything. (certain assets are exempt from creditors up to a certain dollar limit set by your province, including food, fuel, clothing, home equity, vehicle equity, tools needed to do your job, and more

    Disadvantages of Bankruptcy:

    • If you borrow more than $1,000 during bankruptcy proceedings without notifying creditors that you are bankrupt, you could face fines or jail time

    • It will be extremely hard (but not impossible) to get approved for any form of credit for as long as a bankruptcy is on your credit report

    • A bankruptcy can remain on your credit report for six or seven years, depending on the province where you live and your credit bureau

    • Any asset with value above the minimum set by the province, or not otherwise exempt, will be lost and its value will be distributed among your creditors

    • Not all debt can be forgiven by a bankruptcy, including legal fines or judgements like alimony and child support, student loans that are less than seven years old and secured debts like a mortgage, a car lease or a secured line of credit

    • If you have surplus income beyond what your province allows, you will have to pay your trustee half your surplus income each month 

    • If after seven months of a first bankruptcy, your total surplus income exceeds $200 a month, your bankruptcy will be extended from nine to 21 months with surplus income payments each month

    What are The Advantages and Disadvantages of Debt Settlement?

    Here are some of the main advantages and disadvantages of pursuing a debt settlement.

    Advantages of Debt Settlement:

    • Helps you avoid bankruptcy and surrendering assets

    • You can arrange it yourself, saving time and money

    • You can pay less than what you owe over a finite amount of time

    • Lower monthly payments

    • Doesn’t lower your credit score as much as bankruptcy

    • Resolves debt quickly (most settlement plans last two to three years)

    • Payment arrangements are based on your financial situation

    Disadvantages of Debt Settlement:

    • Debt settlements are voluntary for creditors and they don’t have to negotiate with you

    • Your account will have to be delinquent before creditors will negotiate a debt settlement, harming your credit

    • Some creditors can still pursue and demand payment while you work out a settlement with others

    • You will pay a high fee if you hire a debt settlement company to negotiate on your behalf

    • Your debt can still increase while fulfilling a settlement plan thanks to late payment penalties and accumulated interest

    • If your creditors record your debt settlement on your credit report negatively, it can affect your credit long after you’ve paid back the settlement

    Which is The Least Expensive Debt Solution?

    The least expensive debt solution between bankruptcy and a debt settlement actually depends on your personal financial situation. 

    If your income is vastly greater than the monthly surplus income  limit allowed under bankruptcy, ($4,178 for a family of four and $2,248 for an individual ) you’ll have to pay half that surplus over the limit to your bankruptcy trustee. Also, if your income averages $200 over the limit for seven months, your bankruptcy will be extended from seven to 21 months.

    If you’re a person with lots of personal assets of significant value beyond what your province allows you to keep, you will have to surrender them. Finally, if you have any legal judgments against you or a secured debt, you will still have to pay those back.

    You may think a debt settlement is less expensive  than bankruptcy, but bankruptcy and its consequences end after six or seven years, a debt settlement does not. Plus, after paying a settlement, you may file for bankruptcy anyway.

    Bottom line, bankruptcy is more expensive in the short-term, but it may actually be cheaper if you don’t have many assets, surplus income, or any secured debts you must continue A debt settlement may cost you more in the long-term,  especially if not all your creditors buy in or you get in more debt while engaged in it.

    How Do I Rebuild Creditworthiness After Bankruptcy or Debt Settlement?

    Building credit history after a negative event is more common than you might think. Here are steps you can take to rebuild your credit after going through a bankruptcy or debt settlement.

    Get your credit report

    You can simply sign up for a free account with Borrowell and check your credit report whenever you want. You’ll need it to verify the contents and that there are no errors. 

    Create a budget

    To avoid starting the debt cycle again, create a budget so you can see your outgoing expenses, where they are going, and where you need to cut back. It also will help keep you accountable and prevent you from living beyond your means and spending more than you ear

    Start saving

    Make your old plan  payments to yourself and build savings. You need to demonstrate to lenders that you can handle money by showing you can save it, so your savings will become the foundation of your future borrowing. 

    Obtain a secured credit card

    A secured credit card works by placing a cash deposit with the issuing bank that will be your credit limit. Every time you pay back what is charged to the card in full and on time, your activity gets reported directly to the credit bureaus, which helps you build your credit back up. Refresh Financial’s Secured Card is a great place to start if you’re looking to build your credit history.

    Get an RRSP

    Put some of your savings in an RRSP. This will further build your borrowing capital because with enough money in it, you can ask the bank for a small RRSP loan, which gets reported on your credit report and builds your credit as you pay it back, especially if you pay it off quickly.

    Finalizing the Decision

    What hurts your credit more between bankruptcy and a debt settlement depends on your financial situation. The value of your assets and surplus income will influence declaring bankruptcy. Meanwhile, your ability to successfully get your creditors to agree to a settlement (and your ability to pay them) will determine whether you choose debt settlement. How much time you have (potentially nine months for bankruptcy or several years for debt settlement) should also influence your decision. Overall, bankruptcy will make your credit worse in the short-term, while a debt settlement will make your credit only marginally better, but prolong the agony.

    Photo credit: People photo created by wayhomestudio -

    Aaron Broverman
    Aaron Broverman

    Aaron Broverman is a writer and journalist with over a decade of experience. He specializes in personal finance and credit card topics, and his work has appeared in outlets such as CBC, Huffington Post, Yahoo Canada, and Greedy Rates.

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