The Effects of an Insolvency Filing On Your Credit Score!
It’s Just Math Part 2:
This blog post is the follow up to on “It’s Just Math: Should You Fear an Insolvency Filing?” and we delve deeper into the question of credit scores and their real world impacts for the people who may be concerned about this when considering whether to proceed with an insolvency filing to restructure their finances and get back on track.
Credit Scores at their very core are simply a collection of numbers and data to help a lender assign risk so they know how much money they should be charging you for the money that they are lending you. The simplest form of this math is as follows:
Higher risk = Higher Interest Rates = Higher Costs $
Lower Risk = Lower Interest Rates= Lower Costs $*
*(The math above does not take into consideration the compounding periods in compound interest calculations which will be further delved into in another blog post in the future as that is something that can get complicated.)
One can assume that the higher your credit score the less you have to pay to borrow money, and the lower your credit score the more you will have to pay. The scale for your credit score is from 300-900 with 900 being the absolute best. Now this is a number that can have financial effects on you but not more than the financial decisions you make, as those decisions are what determine your credit score.
But first, where you can get your credit score for free?
Before we delve into the numbers it is important to know who the gate keepers are of your financial data, in Canada it is Equifax and TransUnion, these are the two major credit reporting agencies and they compile all your data and sell it to lenders like the banks. Other 3rd party services like Credit Karma, Wealthsimple, and other Financial Institutions Web Application’s use this information to generate a credit report for you. The thing is, these are third party and often will appear different than your full credit report, as provided by the two major credit reporting agencies. To get the best numbers I would always suggest going to the source and get your full credit report, and you can get that one time per year for free at Equifax or TransUnion.
How Credit Scores are calculated?
As far what makes up the credit score it is a combination of several factors such as past payment history, public inquiries, credit account types, credit utilization and creditor inquiries. For full details please see the following links from Equifax and Transunion where they break down how they calculate your credit score:
Equifax: Credit Score Calculation Information
Transunion: What Affects Your Credit Score
How does a Consumer Proposal/Bankruptcy filing affect my Credit score and what to do about it?
So, as you see in the breakdown’s which are both similar for each reporting agency, YES! Bankruptcies or Consumer Proposals are classified as public records and will impact your Credit Score but not as much as you would think as its only about 10% of the weight of your credit score. What actually happens when you make a filing is that the credit account is now delinquent because you are no longer paying the account back in full, in a consumer proposal or bankruptcy it is very rare that the creditor will be getting all their money back, just a small portion of wat was originally owed is paid in an insolvency filing and will go back to the creditors. So if its not paid in full your creditors will assign a rating to that account from R1-R9, which is a scale and R1 is the best rating where you have never missed a payment and paid down the loan without it accumulating interest excessively, and R9 is an account that will never be paid in full. So R9’s are bankruptcies and R7’s which are slightly better are supposed to be consumer proposal’s, however what is assigned is up to your creditor’s and each creditor has a different opinion of this. So, some may stick a particular credit account at an R7 and some at an R9 but whatever it is not up to your Trustee or you, and the reporting agency will simply report it, so it will not be up to them either. As you can see the power lies with your creditor’s in this system, and like if you take a look at the details of your credit account agreements and read through them you will notice that you (the consumer/debtor) is usually powerless to the whims of the creditors.
All the above, always leads me back to the all-important question of:
What is more important to you, having a good credit score or having money?
The answer is always “money!”
The stark fact here is that if you proceed with an insolvency proceeding you do not pay all your creditors in full, so you will have some excess money to balance your monthly budget and be able to save some money, the net result is you actually having money but no credit for a small period of time.
From Equifax we can see that only 10% of the weight of all the numbers that go into your credit score is public records which are things like bankruptcy/consumer proposals, so it is a very forward looking system, if you take the right actions after an insolvency filing (which we go through in financial counselling sessions that are part of your consumer proposal/bankruptcy), you will very likely have a better credit score moving forward, have a balanced budget and money!
The focus after your insolvency filing will be on all those things that have a higher weight like the payment history and credit utilization which total 65% of the make-up of your credit score. What happens if you get new credit accounts and keep these ratios looking great by not using too much of your credit balances available and paying your creditors in full every month. If you guessed your score will likely go up, you are right! The other good thing that happens is when you complete your consumer proposal/bankruptcy the old accounts which were reporting negatively drop off your credit score 3 years after the completion of a consumer proposal, and 6 years after completion of a bankruptcy. So down the line your credit score gets a nice refresh along with your overall finances and can allow you to not have to choose between money in your pocket and a good credit score, you can have both.
What is illustrated here is how the numbers work at their core level, yes you have to do certain things to make the numbers work for you and increase your credit score but they are things that are not terribly difficult to do, and with the proper advice and guidance will become very easy over time
Always remember that with financial knowledge comes financial empowerment, if you know how things work you will not fear them, you will just proceed to make the best financial decisions for yourself and seek further guidance where you need it.
If you need help, ask us your questions, or book your consultation today. At Bromwich+Smith’s Debt Relief Specialists are available for initial free, no-obligation, confidential consultation by phone at 1-855-884-9243, or request a call back at https://www.bromwichandsmith.com/contact-us.