How Bankruptcy Affects Your Credit Score

In India, the consequences of bankruptcy can be mitigated with the help of an established legal framework. It helps address the overwhelming debt, offering a chance to reset and rebuild. However, one of the most significant consequences is its impact on your credit score—a critical factor in securing future loans or credit. Understanding how bankruptcy affects your credit profile can help you take proactive steps to regain financial stability and improve your credit health over time.

Let us first understand the basics by looking at what is a credit score and bankruptcy. Then, let’s look into how the two are related.

Credit Score

A credit score is a number that shows how reliable you are when it comes to repaying loans or credit. In India, it ranges from 300 to 900. The higher your score, the better your chances of getting loans at lower interest rates. This score is based on factors like:

• Payment History: Whether you pay your EMIs or credit card bills on time

• Credit Utilisation: How much of your available credit you’re using

• Length of Credit History: How long you’ve had credit accounts

• Credit Mix: The different types of credit you have, such as loans and credit cards

• Recent Credit Applications: New applications for loans or credit cards

Bankruptcy

Bankruptcy is when you can no longer pay off your debts. In India, it’s governed by the Insolvency and Bankruptcy Code (IBC), 2016. Filing for bankruptcy allows you to either reorganise your debt or sell off assets to pay back creditors. It offers a fresh start while ensuring creditors recover as much as possible.

So, how are credit scores and bankruptcy linked?

Filing for bankruptcy tells lenders you’re in financial trouble and can no longer manage your credit. As a result, your credit score can drop sharply. Bankruptcy stays on your credit report for up to 10 years, making it harder to get new loans. Lenders may see you as a high-risk borrower, so they might either reject your applications or charge higher interest rates. Although bankruptcy affects your credit score, it’s not permanent. With steady financial discipline, you can rebuild your credit and regain control of your financial future.

Under the IBC, the insolvency process can be started by you (the debtor) or by your creditors. Here’s how it typically unfolds:

• File an application

A creditor or the company must file an application for insolvency with the National Company Law Tribunal (NCLT)

• NCLT admits the petition

The NCLT will admit the petition and pass an order to start the process. The date of the order is the insolvency commencement date (ICD).

• Appointment of the IRP

The NCLT will appoint an interim resolution professional (IRP)

• Formation of a committee

A creditors committee is formed to decide on the resolution and action plan for you

• Submission of plans

Resolution plans are submitted and evaluated

• Approval

After thorough review and analysis, the NCLT approves the plan

It is essential to note that the IBC offers different ways to tackle bankruptcy, depending on your financial situation and aggregate debt. The various processes you can apply for are as follows:

1. Fresh Start Process

The Fresh Start Process is designed for individuals with minimal debt and limited assets. This option provides relief without undergoing the full bankruptcy proceedings. It’s ideal if you’re struggling to repay small debts but don’t have significant resources to liquidate. To be eligible for the Fresh Start Process, you must fulfil the following criteria:

• Gross annual income of ₹60,000 or less

• Total assets valued at ₹20,000 or less

• Debts not exceeding ₹35,000

• No ownership of a home or land

2. Insolvency Resolution Process

This process is for individuals, partnership firms, and businesses unable to repay their debts. It focuses on restructuring debts through a resolution plan, allowing you to reorganise your finances. This enables you to make the required payments gradually under an approved plan. Furthermore, the process allows you to retain control over certain financial and business operations. Here are some essential pointers about this process that you should know about:

• Either you or your creditors can initiate this process by filing an application with the appropriate tribunal

• Individuals may approach the DRT, while companies can reach out to the NCLT 

• During this period, creditors are barred from taking legal actions against you

• A resolution professional is appointed to draft and present a repayment plan

• The plan must be approved by the creditors

3. Bankruptcy Process

The bankruptcy process is a last resort when restructuring through the insolvency resolution fails. It involves liquidating your assets to repay creditors. The process provides a clean slate by discharging any remaining debts after the liquidation of assets. Additionally, it offers legal protection from creditors, ensuring they cannot pursue further claims against you once the bankruptcy is complete. Here are the key details of this process

• You or your creditors can file for bankruptcy if the resolution process doesn’t work

• A trustee is appointed to manage and sell your assets

• Proceeds from the sale of your assets are distributed among creditors

• Once the bankruptcy process is completed, you are discharged from your remaining debts

Typically, filing for bankruptcy has a major impact on your credit score, both, immediately and in the long term. The moment you file for bankruptcy, your credit score takes a sharp hit. Bankruptcy is a clear signal to lenders that you’ve encountered severe financial difficulties. Here’s how it affects your score in the short and long term:

Significant Drop

Depending on the debt amount, number of creditors, and other factors, you could see a drop of about 200 points or more

Record on Credit Report

The bankruptcy filing is immediately recorded on your credit report. This negative mark stays visible for a significant period, affecting your creditworthiness.

Duration of Impact

In India, a bankruptcy record can remain on your credit report for up to 10 years. During this period, it acts as a warning to lenders, making it harder for you to secure new credit.

Difficulty in Accessing Credit

Lenders may be hesitant to approve loans or credit cards. If they do, they might offer higher interest rates or stricter terms due to the perceived risk.

Impact on Loan Approvals

Even after bankruptcy, your ability to get large loans, like home or car loans, could be limited. Many lenders prefer borrowers with clean credit histories.

 

Although bankruptcy impacts your credit significantly, it’s not the end of the road. With consistent efforts, you can rebuild your credit over time. Here’s how:

Start with Secured Credit

After bankruptcy, you may not qualify for traditional unsecured loans or credit cards. Instead, consider applying for a secured credit card, where your credit limit is backed by a deposit. Use it responsibly to build a positive payment history. You can then consider getting a secured loan by pledging gold or other assets as collateral.

Timely Payments

Ensure you pay all bills, EMIs, and any remaining debts on time. Payment history is a crucial factor in rebuilding your credit score.

Maintain Low Credit Utilisation

Keep your credit utilisation ratio (the percentage of credit you use compared to your limit) low. A lower ratio positively impacts your credit score.

Avoid Unnecessary Credit Applications

Each application for new credit results in a hard inquiry, which temporarily lowers your score. Apply only when necessary.

Monitor Your Credit Report

Regularly check your credit report for errors or inaccuracies. Correcting mistakes can improve your score over time.

 

Once the bankruptcy is removed from your credit report, typically after 10 years, your score can improve significantly. However, this is subject to your financial behaviour during and after bankruptcy.

 

With disciplined financial habits, your score may start to improve within a couple of years, post bankruptcy. The pace of recovery depends on your ability to demonstrate responsible credit use.