How does insolvency affect your credit score?

Answering a common question from those considering insolvency.

People considering insolvency options for themselves or their company often ask us - "how will this affect my credit score?". A credit score (or interchangeably referred to as a 'credit rating') is a numerical score based on your past credit experience which includes your borrowing and repayment history, your previous applications for credit, et cetera. Lenders will take your credit score into account when deciding whether to give you credit or finance. The total range of the score can depend on the particular credit reporting agency, however it is generally accepted that the higher the score, the more likely you are to be approved for credit. 

 Asking whether there will be an impact on your credit score is equivalent to, in effect, asking whether it will be any more difficult to obtain credit and / or finance. For the purposes of this article, we discuss the idea of obtaining credit / finance interchangeably with the impact on a credit score.

 There are several events which can negatively impact (i.e.: decrease) your credit rating. These include things like: 

• If your current credit limit exceeds your ability to pay;

• Any issues you've had in repaying current or previous loans (e.g: missing your mortgage payments); and

• Any default judgements relating to unpaid debt against you.

 Below we examine the typical situations we see where insolvency can affect your ability to obtain credit and / or finance.

Personal bankruptcy

 According to the Australian Financial Security Authority’s (AFSA) website [1], credit reporting agencies keep a record of your bankruptcy of a period of 5 years from the date you became bankrupt, or 2 years form when your bankruptcy ends, whichever is later. While after this period it can be removed from your credit report, the record of your bankruptcy will remain on the National Personal Insolvency Index (NPII) forever, (assuming your bankruptcy is not annulled).

In addition to the above, while you’re bankrupt, the Bankruptcy Act 1966 and Bankruptcy Regulations 2021 provide that you must disclose your bankruptcy before you can buy goods or services on credit or by hire purchase up to an indexed amount currently set at $6,852.

The exact numerical impact on your credit score is not clear, and would likely range amongst different credit reporting agencies, however research suggests that there is typically an immediate drop in your credit score which then reduces over time.

Director of company in liquidation

It is more difficult to measure the impact on your credit score when you are the director of a company that enters into liquidation.

Generally, liquidation of a company will not have a direct impact the consumer credit file / credit score of the directors of the liquidated company.  An important concept to note here is the idea that a company is a separate legal entity to its director and as such, a director is not automatically liable for any and all company debt. 

A director can be liable for certain company debts – for example, debts to suppliers for which the Director has personally guaranteed. In the commonly seen situation where that supplier does not get paid in full from the liquidation of the company, it is likely that the supplier will look to recover any shortfall under the personal guarantee. In the event this is not paid, the supplier may take some further action, which could include the supplier issuing debt recovery proceedings and seeking to obtain judgement in relation to the unpaid debt. This judgement could have a negative effect on your credit rating.

There may also be additional claims that a liquidator may have against a director flowing on from the liquidation of a company, including claims for any unpaid loans, insolvent trading and the like. These liabilities will also be taken into account by any lender or credit provider when considering your personal financial situation and capacity to repay any finance. 

In addition to the above, it’s likely that any lenders would conduct a search of ASIC’s database using your name. Through this search, a credit provider could identify whether you have been an appointed director of a company that has been placed into liquidation. Depending on the credit providers internal risk appetite, this may impact their willingness to provide any finance / credit.

Recommendations to mitigate any adverse impacts of insolvency on your ability to obtain credit/finance  

1. Use the insolvency as a springboard into a life of better managing your debts. Be aware of your current financial position and only incur new debts should this fit within your capacity to repay. Bankruptcy, for instance, allows a very useful platform to rid yourself of old debts and start afresh.

2.  Many lenders are aware that directors of companies that have entered into liquidation may have unquantified liabilities to that company (e.g: liability for insolvent trading). In the event there is no such liability, we are able to provide directors a letter confirming that there is no known debt to the Company. This can assist the credit provider / lender in having more comfort around the director's financial position.

3. Start saving. Concerns that a credit provider or lender may have from any past insolvency dealings on your credit file may be mitigated if they can see that, despite the insolvency, you can demonstrate a good ability to save and a good capacity to meet any future finance obligations.

4. Work with your lender. If your lender has concerns regarding your past insolvency, work with them to provide an understanding of the timeline of the insolvency, any particular circumstances that may have led to the insolvency and why those circumstances may not be present moving forward.

5. Consider approaching non-traditional lenders. Major banks are typically more rigid in their approach and are more likely to decline providing finance if there is a history of insolvency on your record. It is worth approaching non-traditional lenders to consider your options. However, be cautious that non-traditional lenders may have higher interest rates or other onerous terms.

If you have any questions or concerns about what you can expect when facing insolvency, or if you are otherwise considering your insolvency options, please reach out to your local Worrells principal for information and guidance.

[1] The end of a bankrupt's period of bankruptcy | Australian Financial Security Authority (afsa.gov.au)