Insolvency and its effect on your credit score

Posted by Tom Blandford in Dealing with Debt on 17 November 2016 - Tom is a Credit Analyst at checkmyfile

Contrary to the belief of some, insolvency is not a ‘get out of jail free card’. When you are declared insolvent, the entry remains reported for 6 years on your credit file and will continue to pose a significant barrier to your chances of obtaining credit – even after the insolvency is discharged.

Insolvencies come in several forms, each with different criteria. The most well-known is the bankruptcy - often over-generalised as a blanket-term for all insolvency, a bankruptcy can be petitioned for by an individual or their creditors where £750 or more is owed. As part of this insolvency, assets may be sold in order to repay the debts and the resulting funds are then split proportionally between each creditor based on the amount of debt owed to each creditor. In Scotland, the bankruptcy’s closest relative is called a Sequestration. To apply for a sequestration, over £1,500 must be owed in unsecured debts and there must be no other realistic solution available to relieve the individual’s debt.

Both bankruptcies and sequestrations can be discharged after a year from the date of insolvency, at which point a copy of a discharge certificate issued by the court can then be sent to each creditor included in the bankruptcy order. Typically, this will mean that the relevant credit agreements will be marked as satisfied (or partially satisfied) along with the insolvency’s entry as discharged.

Another common form of insolvency is an Individual Voluntary Agreement (IVA). This is available to those who owe at least £12,500 in unsecured debt where 75% of the creditors included in the agreement have voted to accept a payment proposal. Its nearest Scottish equivalent is a protected trust deed, where applicants are required to pay at least £50 per month, as well making a minimum total repayment of 10% of their total debt.

The key difference between these insolvencies is the length of time until completion – IVAs are usually completed within 5 years, whereas protected trust deeds can be completed as soon as 3 years after the date of insolvency. In both cases, repayments are usually made for the same length of time as the time until completion, as both agreements are legally binding, defaulting on an IVA or protected trust deed can lead to the creditors petitioning for bankruptcy.

Often dubbed ‘bankruptcy light’, Debt Relief Orders (DROs) can also appear on credit reports however the requirements are very specific as to not conflict with other forms of insolvency. The total amount of debt must be lower than £15,000, the individual must work for minimum wage, cannot own their own home, the individual cannot have more than £50 income spare each month and a DRO must not have been petitioned for in the last 6 years. The upside to a DRO is that it is easily affordable in comparison to a bankruptcy or IVA, which can often be too expensive for those already struggling for money. Similarly to IVAs and bankruptcies, DROs also have a Scottish equivalent called a low income low asset bankruptcy (LILA).

Despite the differences between each form of insolvency, they are all reported similarly to the credit reference agencies. Each insolvency is reported for 6 years from the date of insolvency and are marked as discharged once its completion requirements have been met.

A common misconception associated with insolvencies is that the accounts included in the order are removed once the insolvency’s expiry date has been reached however this is not quite true. Once an account has included in an insolvency, the relevant lenders also mark the accounts as defaulted, however, there can be some variation as to how soon lenders report the default status. Defaulted accounts are reported for 6 years from the date of default so there can therefore be a delay in the accounts dropping off a credit even when the insolvency they were included in is no longer visible on the file.

Until an insolvency expires and is removed from an individual’s credit file, its negative influence also lingers on their credit score. When an insolvency is discharged, it merely indicates that the repayments are no longer ongoing – lenders, landlords and employers would still usually be extremely cautious of accepting the application as the insolvency can still be considered evidence of a past unreliability keeping up with payments. Once the entry is removed however, it will not be visible to potential lenders nor will it be factored into credit score calculations.

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