Debt Settlement vs. Bankruptcy: Which Is Right for Canadians?

The burden of debt may seem like an insurmountable challenge, particularly to Canadians who have to deal with increased expenses and high-interest rates. When you find yourself unable to make payments, you might be considering debt settlement or bankruptcy as a possible option to restore your financial stability. Both solutions provide a way out of debt, but they have different procedures, expenses, and repercussions. This article will compare debt settlement with bankruptcy in Canada to enable you to know which one suits your financial status. This article will compare debt settlement vs. bankruptcy in Canada so that you can get to know which option suits your financial situation.      

Understanding Debt Settlement in Canada

Debt settlement involves negotiating with creditors to pay less than the total amount due, and is usually done on unsecured debt, such as credit cards, personal loans or payday loans. In Canada, debt settlement may be informal (direct negotiation or through a debt settlement company) or formal (through a consumer proposal under the administration of a Licensed Insolvency Trustee).  The Office of the Superintendent of Bankruptcy notes that consumer proposals have gained popularity in recent years, now accounting for over 80 per cent of all consumer insolvencies. For strategies to manage credit card debt before considering settlement, explore Managing Credit Card Debt in Canada.  

The Debt Settlement Process

• Informal Settlement: You or a debt settlement company negotiate with creditors to lessen the amount of debt and regularly pay 30-70 per cent of the initial balance. The payments are normally in a lump sum or over a short period.
• Consumer Proposal: A Licensed Insolvency Trustee (LIT) will negotiate a legally binding agreement to pay a percentage of your debt (up to $250,000, not including mortgages) over up to five years. The proposal has to be accepted by the creditors, and interest charges cease upon filing.

Advantages of Debt Settlement

• Debt Reduction: In a consumer proposal, you can pay as little as 20-50 per cent of your original debt.
• Asset Protection: You usually retain assets such as your home or car, unlike in bankruptcy.
• Creditor Protection: A consumer proposal puts a stop to collection calls and legal proceedings such as wage garnishments.

Disadvantages of Debt Settlement

• Credit Impact: Debt settlement may attract an R7 credit rating on your credit report that will stay there for three years after you have completed the debt settlement (six years in the case of informal settlements).
• No Guarantee: Creditors can refuse settlement offers, and settlement firms can still charge fees (15-20 per cent of enrolled debt) even when they are unsuccessful.
• Tax Implications: Forgiven debt can be treated as taxable income by the Canada Revenue Agency.

To learn more about debt settlement, go to the Financial Consumer Agency of Canada to learn how to manage debt responsibly.

Understanding Bankruptcy in Canada

Bankruptcy is a legal procedure under the Bankruptcy and Insolvency Act  that relieves individuals who are insolvent, that is, who owe at least $1000 and are unable to pay their debts. Under the administration of an LIT, bankruptcy entails the surrendering of non-exempt assets to clear most of the unsecured debts, including credit cards, personal loans, and tax debts. To understand the risks of accumulating unmanageable debt, check out The Pitfalls of Credit Card Debt.

How Bankruptcy Works

• Eligibility: You should be a resident of Canada, have a debt of at least $1000 and demonstrate insolvency.
• Process: An LIT fills paperwork, sells non-exempt assets (exemptions differ by province) and handles creditor payments. The duration of a first-time bankruptcy is usually 9-21 months, depending on income.
• Discharge: Most unsecured debts are forgiven upon completion, providing a new financial beginning.

Advantages of Bankruptcy

• Elimination of Debt: The majority of unsecured debts, such as credit cards and tax debts, are eliminated.
• Immediate Relief: An automatic stay prevents collection calls, wage garnishments, and lawsuits.
• Fast Tracking: A first-time bankruptcy may be completed within nine months, provided you have no surplus income.

Disadvantages of Bankruptcy

• Credit Impact: Bankruptcy attracts an R9 credit rating on your credit report that stays on your credit report 6-7 years for a first bankruptcy (up to 14 years in subsequent filings).
• Asset Loss: Home equity or investments, which are non-exempt, can be sold.
• Cost: The minimum cost is about $1,800 with extra charges on excess income (50 per cent of income exceeding a government-determined limit).

Learn more about bankruptcy processes from the Office of the Superintendent of Bankruptcy, which reported a 10.8% increase in consumer bankruptcy filings in 2024 due to economic pressures.

Key Differences Between Debt Settlement and Bankruptcy

Factor	Debt Settlement (Consumer Proposal)	Bankruptcy
Debt Reduction	Pay 20–80% of unsecured debt over up to 5 years (no interest)	Most unsecured debts discharged; may involve surplus income payments
Credit Impact	R7 rating; remains on credit report 3 years after completion or 6 years from filing (whichever is sooner)	R9 rating; remains on credit report 6–7 years from discharge (first bankruptcy), 14 years for second
Asset Retention	Keep all assets (if secured payments are maintained)	Risk of losing non-exempt assets (varies by province)
Cost	Trustee fees included in monthly payments (approx. 20%)	Fixed filing fees ($1,800+), plus possible surplus income payments
Duration	Up to 5 years (60 months) maximum	Most unsecured debts are discharged; may involve surplus income payments
Legal Protection	Stops collection actions and interest accumulation	Stops collection actions and interest accumulation

Debt Settlement is the best option for people who have a stable income, can make partial payments, and do not want to lose their assets. Bankruptcy is more extreme and suits those with excessive debt, little to no assets, or no capacity to pay, and it is a quicker but more severe solution. For another debt relief option, learn about Debt Consolidation Demystified.  

Which Option Is Right for You?

The decision of whether to settle your debts or file for bankruptcy depends on your financial situation:

• Debt Amount: In case your debt (not including mortgages) is less than $250,000, a consumer proposal can be a viable option.  Bankruptcy or a Division I proposal might be required in the case of larger debts.
• Income: A steady income helps in the repayment plan of a consumer proposal, and a low or no income is in favour of bankruptcy.
• Assets: In the event that you own substantial assets (e.g., home equity), a consumer proposal enables you to retain them.
• Credit Goals: The long-term credit effects of bankruptcy (R9, 6-7 years) can be more significant than the short-term R7 rating of debt settlement.

Consult a Licensed Insolvency Trustee (LIT) for a free, personalized review of your financial situation and to explore all available options. After choosing an option, rebuilding your credit is key. Explore Credit Score Repair Tips for Canadians for practical steps to improve your credit post-debt relief. 

Conclusion

Making the choice between debt settlement and bankruptcy is one of the most important steps on the road toward financial recovery.  Debt settlement, especially in the form of a consumer proposal, is flexible and protects assets but involves repayments on a long-term basis. Bankruptcy entails faster solutions at the expense of assets and a serious credit hit. Both alternatives put an end to creditor harassment, yet their effects are different in the long term. Consider your income, assets, and debts to make the best decision by consulting a professional. To make the best choice, evaluate your income, assets, and debt levels with a Licensed Insolvency Trustee. Explore reputable financial resources and consult a professional to start your journey to financial freedom.