How to Liquidate Debt

Melissa Lyken

February 12, 2021

You can win against even the biggest debt collectors.

Summary: Are you having trouble paying off your debts? Not sure if it will ever go away? Learn how you can liquidate debt by eliminating it or negotiating to pay it off faster.

Are you having trouble paying off credit card debt, a mortgage, or an auto loan? Have you just had a salary cut and can no longer meet all of your monthly expenses? If so, it may be time to liquidate your debt. Like companies that have liquidation sales, personal debt liquidation involves selling assets to reduce or pay off a debt owed. You can do this voluntarily after examining different options or filing for bankruptcy. Be sure to investigate your options before converting any of your assets to cash to liquidate your debt. Let's take a look at your options.

Analyze Your Debt

Before looking at the different debt liquidation options you can explore, you will need to determine how much debt you need to pay off. Contact your creditors and find out if they are willing to negotiate friendly terms of payment. At this point, the objective is to improve your financial condition by freeing up some cash. If your creditors do not agree to this arrangement, you can execute the following strategies.

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Make a Consumer Proposal to Your Creditors

If your total debt is less than $250,000, a consumer proposal may be the option for you. The proposal is a plan to pay creditors a percentage of the money you owe or extend the time for repaying debt. It's the most preferred option if you don't want to file for bankruptcy.

If the creditors accept the proposal, you can keep your assets, including savings, cars, houses, investments, among others. It also requires debtors to appoint a Licensed Insolvency Trustee, LIT, to help them divide the money among creditors. This trustee is the only professional allowed to administer government-related insolvency proceedings that enable the debtor to be discharged from debt.

A consumer proposal is one such proceeding hence the need to appoint the trustee. The professional helps you develop a proposal to woo your creditors. The LIT then presents the request along with a report of your situation explaining the causes of your financial difficulties.

The law requires the creditors to respond within 45 days. The LIT also files the proposal with the Office of the Superintendent of Bankruptcy, or OSB, which stops creditors from using other methods to recover the debt. Once filed, creditors must stop actions like filing for wage garnishment orders or lawsuits.

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If the creditors accept the proposal:

  • The debtor is responsible for paying periodic or lump-sum payments to the Licensed Insolvency Trustee.
  • The proposal remains on your credit report for the duration of the proposal.
  • The debtor is required to attend two counseling sessions.
  • You can keep your assets as long as you make payments as agreed.

Once you meet all the payment terms and conditions, you will be released from debts indicated on the proposal. Under the law, the debtor should take a maximum of five years to make payments set out on the proposal.

If the creditors reject the proposal, your trustee can help you make a few changes to make it appealing to creditors. Alternatively, you can explore other options to solve your financial hardship, like filing for bankruptcy.

Withdraw Cash from Your Retirement Accounts to Pay Your Debt

Before selling off your assets, you may want to consider withdrawing money stashed in 401k funds, financial investments, IRA accounts, and applicable life insurance policies. Withdrawing cash from retirement accounts like IRA and 401k accounts before maturity has short-term and long-term effects.

A 10% penalty tax is charged in addition to the income tax charged to the amount withdrawn. The IRS treats such withdrawals as regular income hence the high tax rate. If you choose to withdraw from a life insurance policy, the original maturity period is reduced, minimizing the surrender value.

Insurance companies offer two ways of cashing in traditional life insurance policies: you can convert it to a paid-up policy or apply for an exit policy to get the surrender value. Both options will help you pay off all or a portion of the debt but leave your dependents without a life insurance cover.

Hire a Credit Counseling Agency to Create a Debt Management Plan

It may be in your best interests to enlist the help of a credit counseling agency to help you negotiate payment plans with creditors. Once a plan is set up, you can make monthly payments to the agency, which distributes the money to creditors.

The premise for making a debt management plan is to simplify repayment. Unlike a trustee, a credit collection agency doesn't negotiate the amount of debt owed to your creditors. The agency only arranges details like monthly payments, a waiver for fees charged, and interest rate reduction.

Make a Debt Settlement Offer

This is an arrangement to pay an amount less than what you owe to settle a debt. Third-party companies offer this service by offering to negotiate a settlement with the creditor. While debt settlement helps you pay the debt, it causes your credit score to drop significantly. The creditor is likely to report that the debt was settled, affecting your credit score.

You can explore either of the methods highlighted to liquidate the debt. Be sure to assess your financial situation first to determine what works best.

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File for Bankruptcy

As highlighted earlier, a consumer proposal applies to debtors who owe less than $250,000. If you owe more, you can file a different type of proposal- the 'Division I' proposal. However, if the creditors reject it, your last resort may be to file for bankruptcy if you cannot use other methods to pay off your debts.

A Licensed Insolvency Trustee also presides over this process because it's a government-regulated insolvency proceeding. The professional helps you complete the bankruptcy forms that are presented at the Office of the Superintendent of Bankruptcy (OSB) for review once filed. Once accepted, you'll be declared bankrupt, which means:

  • The LIT deals with the creditors directly.
  • Creditors cannot perform any other action to pursue the debt, including calling you or appointing debt collection agencies.
  • The trustee takes possession of your assets except those exempt under territorial or provincial law (clothing, household goods, etc.)
  • Assets are sold, and the money is used to pay debt and fees related to bankruptcy.

Once you're declared bankrupt, the court goes ahead to discharge you from debt. A bankruptcy discharge releases the debtor from the legal obligation to repay debts owed. However, not all debts are dischargeable. The law requires debtors to continue making support payments, paying for alimony, penalties, and restitution orders.

Being in debt can make you feel like you have no options. It's a stressful and often lonely process. We hope these insights give you a few ideas on how you can effectively liquidate debt and become debt-free.

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