There are different categories of debt and understanding the nuances between them can often be critical to making good decisions regarding eliminating your debt.
It is critical for a debt-challenged consumer to understand the different types of debt and why these distinctions matter. This will enable you to create and your debt profile, a breakdown of your debt by debt category. Your debt profile may, to a significant extent, dictate what is is the optimal debt relief strategy for you.
In this article I am going to attempt to answer the following three questions:
What is the distinction between secured and unsecured debt?
What debts are discharged or forgiven in a consumer proposal or personal bankruptcy
Why does the distinction between consumer debt and monies owing to the government matter?
1. What is the distinction between secured and unsecured debt
A secured debt is a debt where the creditor has collateral it can look to in the event that the consumer fails to make their payments. The most common examples of secured debt are a mortgage on real property and a lien on a car where the purchase or lease of the car was financed. If you don't make the mortgage payments on your house or your car payments then your lender can repossess the property.
Mortgages are not limited to mortgages on land or real property. There are also chattel mortgages on chattels or property other than land. The most common example of a chattel mortgage is the lien on an automobile. There are also chattel mortgages on RVs and boats.
An unsecured debt is a debt that is not a secured debt. This means that any debt that is not a secured debt is an unsecured debt. If an unsecured creditor wants to recover monies on an unsecured debt where the consumer fails to make their payments then ultimately the creditor might have to not only sue the consumer but also enforce a judgment that it obtains against the debtor.
a. Transforming an unsecured debt into a secured debt
There are two scenarios where an unsecured debt can be transformed into a secured debt.
i. Your creditor successfully sues you and places a lien on your property
An example will help illustrate how an unsecured debt can be transformed into a secured debt as the result of your creditor suing you.
Mr. Singh lives in Brampton, Ontario, and he has a Canadian Tire Bank credit card. He owes $16,000.00 on the card and he stops making payments. Canadian Tire Bank sues Mr. Singh in Brampton Small Claims Court. Mr. Singh does not defend the lawsuit and Canadian Tire Bank obtains a $18,000.00 judgment against him, the original $16,000.00, plus additional monies for court costs, legal fees, and post-judgment interest. Mr. Singh and his wife jointly own their principal residence, a home in Brampton. Canadian Tire Bank arranges to place a lien on the property.
In this example, what was originally a $16,000.00 unsecured debt has been transformed into a an $18,000.00 secured debt. When Mr. Singh and his wife either mortgage or sell their principal residence this secured debt owing to Canadian Tire Bank will have to be paid out.
ii. Obtaining a Master Credit Agreement with your creditor
Some individuals who finance or refinance their home will receive not only a mortgage but also a line of credit and one or more credit cards where these credit facilities are secured by the mortgage loan. These are referred to as a Master Credit Agreement. In this scenario, your lender is a secured creditor and if you were not to pay your line of credit or your credit card these would be secured debts.
2. What type of debts are discharged or forgiven in a consumer proposal or a bankruptcy?
Under Canada's federal insolvency law, the Bankruptcy and Insolvency Act (BIA), there are two methods that an honest but unfortunate debtor might be able to eliminate some of their unsecured debt.
It is important to note that when an individual makes a consumer proposal or files for personal bankruptcy he or she is not eliminating any of their secured debt. They are only eliminating some or all of their unsecured consumer debt.
When a Canadian makes a consumer proposal or files for personal bankruptcy the following debts are NOT discharged or forgiven:
Any secured debt
Spousal support and/child support
Government fines
Debts arising due to fraud
Student loans were the individual did not cease attending school at least seven years ago
The Federal Government takes the position that overpayments in connection with various government assistance programs including unemployment insurance and social assistance arising from false information provided by an applicant constitute fraud and therefore these debts are not discharged where there has been a consumer proposal or a bankruptcy.
3. Why does the distinction between consumer debt and monies owing to the
government matter?
A consumer debt is a debt arising from a consumer transaction. Monies owing to the government arise where an individual owes monies to a municipal, provincial, or federal government. The latter might include the following:
property taxes
Government fines
Income Tax and H.S.T.
A consumer has many significantly more debt relief options available in connection with consumer debt compared with monies owing to the government.
If you owe monies to the Government then your options with respect to that debt are limited to making a consumer proposal or filing for personal bankruptcy. In contrast, if you own consumer debt then you can choose from a number of debt relief options:
credit counseling
debt settlement (informal settlement with your creditor)
consumer proposal
personal bankruptcy
In this short YouTube video former collection agency lawyer Mark Silverthorn describes the different categories of debt and their significance.
A consumer's "debt profile", or the percentage of a consumer's indebtedness in each debt category might, to some extent, dictate his or her optimal debt relief option.
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