Can insolvency be good for your credit rating?
In a world where we are becoming increasingly dependent on credit to navigate the journey of life, whether to study as a student, to buy a home or to start a family, at Creditfix we find one of the most important concerns our clients have relate to their credit scores.
What is a credit score?
A credit score is classifications that credit reference agencies give consumers, based on their financial history. Credit reference agencies then share this information, with the consent of the consumer, with financial institutions and sometimes their potential employers. It is supposed to show the creditworthiness of the consumer and what risk they present to the lender.
For example, is the person likely to repay the money they borrow? In terms of potential employers, it may indicate whether the potential employee is financially distressed, which may be relevant when deciding if that person is suitable for a position that involves working in finance or a position of trust.
For many who have financial difficulties, this is often very important to them, as going forward if they are not able to access credit or certain jobs, a difficult situation can quickly become a bad one.
How do credit reference agencies work?
Credit reference agencies are private businesses and there are three main agencies in the UK (these are Experian, Equifax and Callcredit). Lenders are allowed to share information with these agencies about their borrowers. This can include information about the amount of credit the consumer has the amount of credit they have access to and also their payment history, which may include information about missed payments and whether the person has defaulted on any agreements. Credit reference agencies also gather additional information about people, such as whether a county court judgement had been granted, or in Scotland whether a decree has been awarded.
This information is then used to weigh the risk the consumer may present to those that may lend to them, or may employ them, and gives the consumer a classification, usually a number. Whether a firm then lends to them, or employs them, is for the firm to decide, not the credit reference agency. Most firms will operate a criterion which they will use before lending to someone and this will include assessing a variety of information, including their credit score.
How long does this information remain on your credit file?
How long this information remains on someone’s credit file is important. Normally your payment history and defaults will remain on your credit reference file for up to six years. This means if you are not able to maintain your contractual or minimum payments to your loans and credit cards, the fact you have been experiencing financial difficulties may be information future lenders can see for up to six years after you have actually rectified your default or paid off your debts.
Repairing a credit rating in these situations, obviously, then takes time. The main problem being is if it takes someone 7-8 years to repay their debts, then they can expect their payment history to remain on their credit reference files for an additional six years after they have paid them off.
The consequences of this is if you make mistakes in your life, or face financial difficulties when you are younger, these mistakes can haunt you for some time afterwards, and may affect your ability to get finance for a car or take a mortgage out to buy a home.
Why can insolvency help?
It may appear counter intuitive, but sometimes when someone’s financial difficulties are severe, using a personal insolvency remedy like a protected trust deed, bankruptcy or an individual voluntary arrangement can actually be the best way for that person to repair their credit rating.
The reason being, the sooner you address your debts, the sooner the damaging information may be removed from your credit reference file. So although instinctively we may believe it is better to repay our debts in full, the truth is where it may take up to ten years for us to do so, that is ten years where our accounts may show as being in arrears.
That means our poor payment history may show on our credit reference files for another six years after we have paid our debts off.
Where personal insolvency differs, is in the case of bankruptcy, your debts are discharged when you receive you receive your discharge, which is normally after 12 months. In relation to protected trust deeds, this normally occurs after 4-5 years; and for individual voluntary arrangements after 5-6 years.
This means after you receive your discharge, your accounts are shown as clear, although your payment history can still remain available to your creditors for up to six years after you receive your discharge. However, this is often better than where it would take you significantly longer than 5-6 years to repay your debts.
It is true, that at any time, you may have to inform a lender that you have previously been insolvent, if they ask, and they may take this into consideration before lending to you again; but what will also be evident to them is that you are no longer over-indebted and hopefully managing your finances better.
It is also, however, important to remember for some people, personal insolvency is not the correct option and can be more damaging than just having a damaged credit rating. For those reasons it is also better to obtain qualified advice first.
If you need more information about the options available to you in dealing with your debt, you can always speak confidentially with one of our friendly advisors on 0808 2085 198.