If you find yourself in a position where you’re unable to pay your bills, have growing debts like credit cards and loan repayments and your weekly income is not enough to meet your day-to-day living expenses, then you could be facing personal insolvency. Personal Insolvency is defined as a situation where you are unable to pay your debts when they fall due. Unmanageable debt is not only caused by overspending, although this is a common reason for personal Insolvency. It can also be triggered by factors out of your control. Severe illness, an accident, a job loss, or a relationship breakdown are also common causes. There are a number of options which may provide relief from unmanageable debt. However, some also have long-lasting effects on your credit score and ramifications or restrictions when applying for future finance.
This guide will take you through what options are available and how they impact your credit score.
Types of Personal Insolvency Options
Options are either formal (legislated under the Bankruptcy Act 1966) or informal, which refers to a binding agreement with creditors. The severity of your financial situation will, in most cases, define the path you take.
Formal Personal Insolvency Options
There are four formal personal insolvency options available to you under the Bankruptcy Act, each having a varying level of consequence.
- Declaration of intention to present a debtor’s petition (DOI). A DOI provides you with a 21-day protection period where your creditors can’t take further action to recover their debts. This allows you to seek help and decide on which step to take next.
- Bankruptcy. This option lasts for 3 years and 1 day. At the end of this period, you are released from most of your debts. Bankruptcy should be seen as a last resort and has long-term consequences.
- Formal Part 9 Debt Agreement (DA). This is a binding agreement between you and your creditors to pay a sum which you can afford.
- Personal Insolvency Agreement (PA). This agreement is between you and your creditors to pay an agreed amount in regular instalments, or in a lump sum.
Informal Personal Insolvency Options
An Informal Debt Agreement is a proactive solution set up between you and your creditors which allows you to repay your debts without the lasting consequences attached to other formal debt relief options. An informal Debt Agreement aims to consolidate your debt into one easy-to-manage regular payment, reduce your monthly payments, reduce your interest rate and create a more manageable plan for your debt so you can pay what you can afford. Informal Debt Agreements are outside the formal system, which means it won’t be marked on your credit file.
Personal Insolvency Options and Your Credit File
Your individual financial situation in most cases will dictate your option to your unmanageable debt. If you can afford to pay off the debt, then it is in your best interest to avoid the long-term impact of Bankruptcy on your credit file and enter into a Formal Part 9 Debt Agreement, Personal Insolvency Agreement or Informal Agreement. Debt Agreements are best suited to people who have a property to protect and do not want to have the stigma or ramifications of Bankruptcy on their credit file.
What is Bankruptcy?
Bankruptcy is a legal process that releases a person from almost all of their debts. It lasts 3 years and 1 day from the day you file your statement of affairs. Bankruptcy is a great debt solution for those with serious debt problems with little or no realistic opportunity to pay back those debts. Bankruptcy can help clear your debts, stop creditor harassment and leave you to start fresh.
When you declare yourself bankrupt, a Bankruptcy Trustee registered with the Australian Financial Security Authority (AFSA) will take control your financial affairs. It is possible to be made bankrupt by one of your creditors through a court process which is called a creditor's petition. Most debts including personal loans, credit card debts, debts owed to creditors and debts owed to the ATO are included in a Bankruptcy. Debts that are not included are HECS or HELP debts, child support maintenance, court imposed penalties and fines and damage claim from accidents.
The Effects of Bankruptcy on Your Credit File are Permanent
Although Bankruptcy does allow you to clear your debts and get on with your life, your credit will be as good as destroyed for the next 5 years and you will be on the The National Personal Insolvency Index (NPII) for the rest of your life. The National Personal Insolvency Index is a publicly available and permanent electronic record of all personal insolvency proceedings in Australia. The NPII provides information about individuals who have been subject to proceedings under the Bankruptcy Act. It is available for lenders to check when considering any loan applications. If you can show your Bankruptcy won’t be repeated, you can repay your debts on time and have a stable income, then you’re much more likely to get accepted for a loan after the 5-year period has been exhausted.
Part 9 Debt Agreements
A Part 9 or formal Debt Agreement is also legislated under the Bankruptcy Act. In a Part 9 Debt Agreement your interest is paused, you propose the amount of contributions to be made, the time period for payment (normally 3-5 years) and whether your assets are to be included. Your creditors then vote to accept or reject your proposal. There is also an opportunity to negotiate down the debt amount to be paid. In some cases, the debt amount can be reduced to as little as 20% of the total debt. Negotiations are dependent on the flexibility of the creditors and the cause of debt. In situations where debt has come about by circumstances out of your control, such as severe illness, or a tragic accident, creditors tend to be more understanding and accommodating when reducing the debt. Once the debt is accepted, essentially all of your creditors are bound by it.
Formal Part 9 Debt Agreements are only available to people with who meet the threshold requirements of assets and after-tax income.
The Effects of a Debt Agreement on Your Credit File are Not Permanent
In most cases, your Debt Agreement will only impact your credit file for 5 years and appear on the National Personal Insolvency Index (NPII) from the date the Debt Agreement was made or 2 years from the date the obligations are complete, whichever is later. As your name will only appear on the NPII only a limited time, a Debt Agreement does not have the same permanent effects as Bankruptcy. Depending on your circumstances and how your agreement ends will affect your ability to obtain credit in the future. Keep a positive track record of your Debt Agreement payments to show the lender you can keep on top of your potential loan repayments. This will give you a better chance at getting approved for a loan in the future.
Informal Agreements Have No Impact on Your Credit File
For those who fall outside the requirements, a Personal Insolvency Agreement or Informal Agreement may be available. An Informal Agreement will reduce your overall debt amount through creditor negotiations. The repayment amount will be calculated according to your income, cost of living and debts. Often, this can mean you are only repaying a percentage of every dollar you owe with all future interest pause so you can repay your debt quickly and stress free.
Because it is negotiated privately, an Informal Agreement won’t appear on your credit report and your name won’t be listed on the NPII. However, if you have let debts pile up before entering an Agreement, then your credit rating still may be effected.
The comparison table below shows the effects the different Personal Insolvency options have on your credit file.
|How Long Does it Last?||National Personal Insolvency Index (NPII)||Credit File|
|Bankruptcy||3 years and 1 day from the day you file your statement of affairs.||Your name will appear permanently.||A record of your Bankruptcy is kept for 5 years from the date you became Bankrupt, or 2 years from when your Bankruptcy ends; whichever is later.|
|Debt Agreement||Between 3 to 5 years.||Your name will appear for 5 years from the date the Debt Agreement was made or from the date the obligations are complete; whichever is later.||A record of your details is kept for up to 5 years.|
|Informal Agreement||Tailored to your circumstances.||Under the Bankruptcy Act, nothing will be formally listed.||An individual creditor may list a default on your credit file.|
|Personal Insolvency Agreement||Depends on what you negotiate with your creditors.||Your name will appear permanently.||A record of your details will be kept for 5 years, sometimes longer.|
Appling for Credit While Bankrupt or in a Debt Agreement
The Bankruptcy Act and Regulations contain threshold restrictions limits when it comes to borrowing. Bankrupts and Debt Agreement debtors must disclose their bankrupt or debtor status when seeking to obtain goods or services on credit or by hire purchase for amounts above $5,778 (regularly indexed in line with the Consumer Price Index or the base pension rate). This extends to leasing, hiring or promising to pay for goods and services; or when seeking to obtain an amount by promising to supply goods or render services.
Applying for Credit After Bankruptcy or Have Completed Your Debt Agreement
Many lenders have a policy to decline loan applications made by people that have been Bankrupt. This means they could see the Bankruptcy recorded the NPII or credit file and immediately deem you ineligible for the loan or credit you’ve applied for, regardless of your overall credit score and history. Similarly, when you have completed your Debt Agreement, lenders will check your credit score to decide if they should lend money to you. Although this is the case, you may potentially have a better chance of getting approved for a secured loan than an unsecured loan. It is completely up to the discretion of the individual lender.
Check Your Credit Rating Before You Apply
After you have been declared a discharged bankrupt or have finished your Debt Agreement, it is a good idea to see where your Credit Score is at. You can get a free credit score check from a number of online providers such as My Credit File and Credit Simple. Your credit report will give you an overview of the impact Bankruptcy or a Debt Agreement had on your credit score. It will also give you an indication of how long it will take before your credit score is healthy again. Getting into a better credit position before you apply for your next loan will help increase the likelihood of you getting approved.
Whether you enter into a Part 9 Debt Agreement, a Personal Insolvency Agreement or declare Bankruptcy, all formal personal insolvency options will affect your credit score in some way. But if you can afford to pay back the debt by way of a Debt Agreement or Personal Insolvency Agreement, then the impact on your credit file is far less harsh and is limited. If you choose to not pay back the debt and declare yourself bankrupt, then the effects are permanent. An Informal Agreement with creditors is not viable in all situations. It may not always be agreed to by creditors, but it can possibly be a positive solution for you as it has no effect on your credit file.