What Is Informal Debt Settlement?

What is debt settlement?

Debt settlement involves hiring a debt settlement company to negotiate with your creditors on your behalf. The goal is to pay back a lump sum payment, often less than you owe on your outstanding debts.

The concept is straightforward. If the creditor accepts, you’re done. The problem is that creditors are not required to negotiate with a debt settlement company, and you will still pay a fee.

Be aware that debt settlement companies often charge high upfront fees or promise to erase your debt quickly. Many fail to deliver on their promises, and scams are commonplace. Always ensure you thoroughly understand the costs involved before agreeing to any services.

How does debt settlement work in Canada?

The debt settlement process typically works like this. You enrol with a company and pay monthly fees. The company contacts your creditors to negotiate a reduced payoff, typically aiming for a settlement amount significantly lower than what you owe.

If a creditor agrees, you pay the settlement, and the company takes its cut. Fees typically range from 15% to 25% of your total debt.

The process stalls because creditors refuse to negotiate, especially if you’ve been making regular payments. Debt settlement negotiations usually start after accounts are 90+ days overdue, so companies often advise stopping payments.

That creates leverage, but it also damages your credit, putting you at risk of collection calls or legal action while you wait for a settlement that may never come.

What are the risks of debt settlement companies?

The Financial Consumer Agency of Canada has issued direct warnings about for-profit debt settlement companies. These warnings should be taken seriously.

Fees

Many debt settlement companies charge thousands of dollars before they have done anything.

According to the Office of the Superintendent of Bankruptcy, debt consultants who refer clients to Licensed Insolvency Trustees typically charge about $2,400, with some charging up to $4,200.

These clients could have spoken to a trustee directly, free of charge.

Source: OSB – Review of Business Practices, April 2017

No guarantees

Creditors are not obligated to negotiate. The Canadian Bankers Association has noted that fewer than 10% of informal debt settlement arrangements succeed. If your creditors refuse to participate, you will have paid money for nothing.

Credit damage

Debt settlement companies often advise you to stop making payments to your creditors while they negotiate on your behalf. This results in late payments and missed payments appearing on your credit report, which can significantly lower your credit score before any settlement is reached.

A debt settlement typically remains on your credit report for seven years. That affects your ability to get credit cards or loans, or even to rent an apartment.

Misleading language

Some companies use terms like “government debt relief program” when they actually just refer you to a Licensed Insolvency Trustee to file a consumer proposal. You do not need to pay a third party for that referral.

Source: FCAC – Consumer Alert on Debt Relief

How is debt settlement different from a consumer proposal?

A consumer proposal is a formal debt relief option under the Bankruptcy and Insolvency Act. Only a Licensed Insolvency Trustee can file one. In many cases, your unsecured debts can be reduced by up to 80% through a consumer proposal.

Source: Government of Canada – Consumer Proposals

With a consumer proposal, you receive immediate legal protection from your unsecured creditors. Collection calls stop. Wage garnishments stop. No creditor can opt out once the majority approves the proposal.

With an informal debt settlement agreement, you get none of that protection. Each creditor can accept, reject, or ignore your offer. While you are waiting for a response, they can continue collection efforts, add interest, and even sue you.

With a proposal, you know your monthly payments from day one, you know your creditors are bound by the settlement agreement, and you know when you will be debt free. Your payments are fixed, so there are no surprises.

Feature	Debt Settlement	Consumer Proposal
Legal protection	None	Immediate
Creditor participation	Voluntary	Binding once majority approves
Impact on credit report	7 years from settlement	3 years after completion
Success rate	Less than 10%	Over 99% when filed by LIT
Typical debt reduction	Varies widely	Up to 80%
Monthly payments	Lump sum is usually required	Lump sum is usually required

What about other debt solutions?

Before considering debt settlement, you should know what other options are available. Your options depend on your financial situation, your credit rating, and the amount you owe.

Credit counselling involves working with a non-profit credit counselling agency to create a debt management plan. A credit counsellor helps you budget and may negotiate lower interest rates with your creditors. You still pay the entire amount owed, but the interest relief can make your payments manageable.

Debt consolidation means rolling multiple debts into a single loan with a lower interest rate. This works if you have good credit and enough income to handle the payments. It simplifies your finances but does not reduce the amount you owe.

Bankruptcy is sometimes the sensible option when your debts are too high relative to your income. It is not the end of the world. I see people every week who assume bankruptcy will ruin their lives, only to find their credit score recovering within two years.

For most people with unsecured debts, such as credit card debt and personal loans, a consumer proposal or bankruptcy through a Licensed Insolvency Trustee offers more protection than any informal settlement.

Frequently asked questions

Can I settle my debts on my own without a company?

Yes. Call your creditors directly and offer a lump sum settlement. Get any agreement in writing before sending payment. This avoids the high fees that debt settlement companies charge and gives you direct control over the debt settlement negotiations.

Will debt settlement hurt my credit score?

Yes. A settlement shows you paid less than the full amount owed, and any missed payments during negotiation also appear on your credit report. Plan for a recovery period of one to two years if you work at rebuilding your credit.

Can I include CRA tax debt in a debt settlement?

Not through an informal settlement. CRA rarely agrees to negotiate directly. A consumer proposal or bankruptcy is the formal option that can include tax debt along with your other unsecured debts.

Are debt settlement companies regulated in Canada?

Regulation varies by province. In Ontario, debt settlement companies must register under the Collection and Debt Settlement Services Act, which bans upfront fees. However, some companies operate under a law firm’s umbrella to avoid these rules. Check for consumer complaints with your provincial consumer affairs office before signing anything.

What happens if my creditors refuse to negotiate?

You still owe the full amount. Any fees you pay to a debt settlement company are typically non-refundable, and the creditor can continue collection efforts. Meanwhile, accrued interest and penalties increase the total amount you owe while payments are on hold.

How is a debt management plan different from debt settlement?

A debt management plan through a credit counselling agency helps you pay back what you owe in full, usually at reduced interest rates. Debt settlement aims to pay less than you owe. A debt management plan better protects your credit rating, but does not reduce your principal balance.

Should I stop making payments to settle my debts faster?

Stopping your debt payments damages your credit score, triggers late fees, and increases your total debt due to accruing interest. Creditors may also pursue legal action while payments are withheld. If you are considering this approach, speak with a Licensed Insolvency Trustee first.

Learn more about debt relief solutions

If you’re dealing with debt issues, the best first step is to consult a Licensed Insolvency Trustee rather than a debt advisor or settlement firm.

A trustee is a federally licensed expert who can clearly outline your debt options without trying to sell you anything.