Settlement of a Loan is frequently confused with loan closure. But because they are two distinct concepts, they have differing effects on credit scores. The loan account will naturally terminate once the loan has been repaid if you make your monthly payments consistently and on time during the duration of the loan. The same information is then forwarded to the credit rating agencies, which raises your credit score.
A loan settlement, on the other hand, happens when the borrower is unable to make payments because of unforeseen circumstances. When an unnatural loan account closure is reported to the credit agencies, it lowers the credit score and makes it harder for the borrower to acquire loans in the future.
How does Loan Settlement work?
When you consent to a debt settlement, you should be ready to accept a drop in your credit score. Not all debtors who are unable to pay back a loan will automatically be eligible for the process.
- The lender confirms and validates that the defaults are attributable to real factors outside of the borrower’s control.
- The lender presents a one-time settlement choice when the information is verified. The lender consents to pay off the interest and penalties and settle the debt with a single payment that is less than the total amount still owed. After determining the borrower’s ability to repay and the gravity of the issue, the settlement sum is chosen.
- The lender writes off the debtor’s loan, cancels the loan account, and marks the loan as “settled” on the credit bureau records once the debtor pays the loan settlement payment.
What procedure does a Lender follow here?
Lenders may give a 6-month no-repayment term if they are confident that you have a legitimate cause why you can’t make your payments. If you agree to pay off the loan in one payment, this option will only be presented to you. In order to make it simpler for the borrower to pay off the loan, the lender will deduct a specified amount from the original loan amount.
Depending on how serious the situation is and the borrower’s ability to make payments, a certain amount will be written off.The loan’s status will be noted as “settled” as a result of this arrangement for a sum less than the actual balance owed. In contrast, the loan would be marked as “closed” if the borrower had fully paid the remaining debt.
How does the repayment of a loan affect your Credit Score?
Every time a lender decides to cancel a loan, he or she promptly notifies CIBIL and other rating organizations of the decision. Even when the loan transaction is settled, it still doesn’t conclude in the way that most transactions do. As a result, the transaction is labeled as “settled” by credit rating agencies, which causes other lenders to perceive it as a bad credit behavior.
As a result, the borrower’s credit rating declines. These organizations also save this data for a period of seven years. If the borrower wants to take out another loan during this time, the lender could be concerned about the borrower’s capacity to repay the loan. There is a chance that the loan application will be turned down by the lender. Additionally, lenders will be wary of approving your loan application during this period and could even reject it. Therefore, unless you have no other way to repay the debt, it is not preferable to settle the loan.
Impact of loan settlements on CIBIL Score
A bank or other lender will notify CIBIL when it is writing off a debt. CIBIL does not take into account the fact that the connection between the bank or lender and the borrower has ended. They refer to the deal as settled rather than concluding it. A loan’s term settlement is considered a poor credit behavior, and the borrower’s credit score declines by 75 to 100 points as a result.
This record has been held by the CIBIL for almost 7 years. Therefore, if the borrower has to take out a loan at that time, it is possible that the lenders will disapprove of them and try to avoid offering them any loans.The banks and lenders mainly look for the borrower’s past repayments before considering offering him a loan. And if the borrower has the settlement in his credit report, the banks and lenders will reject the loan.
Things to keep in Mind
- Loan money just what you can afford to repay and for what you need. Keep your borrowing to a minimum so that you don’t have trouble paying it back.
- The major purpose of a one-time settlement option is to allow the lender to finish the transaction with whatever you are able to pay since they will be certain that you will not be able to repay the loan. Because of this, they would want to close the sale with whatever they can obtain from you.
- With a “settled” status, your credit score will suffer significantly. Your future ability to get loans will be hampered as a result.
Other Options To Avoid Loan Settlement
A loan settlement may seem like an attractive option (reduced repayment amount), but accepting the offer may not be a wise financial decision (negative impact on the credit score). In fact, accepting a loan settlement offer should be your last option. If you find it difficult to make repayment each month, look for alternative financing options.
Although accepting the offer to settle the loan may seem like an appealing alternative (paying less than the amount owed), doing so might have far-reaching financial repercussions. Your very last resort should be to accept a loan settlement offer.
When considering a debt settlement offer,
- To pay off the debt, use your money or sell your stocks and other belongings.
- Take out loans from relatives and friends.
- Consider a gold loan or another low-interest loan.
- Talk to your lender about refinancing your loan, lowering the interest rate, or extending the payback period.
- Take out an insurance policy to protect the debt, and make prompt premium payments. In the event of a default, the insurer compensates the lender.
Way out for Borrowers
Avoid accepting the initial One Time Settlement option that your lender or bank may give you if you as the borrower are having trouble repaying your loan due to circumstances like unemployment, an accident, or a serious medical condition. The settlement will lower your credit score, so keep that in mind. To pay off your debt, you may alternatively try to sell off some of your assets or a portion of your portfolio. Contact your family and friends if you are unable to do that. Avoid settling at all costs.
Maintain the settlement as your final resort if you have no other choice. However, you might speak with your lender or bank about extending your payback duration, getting a shorter repayment term, or getting the interest waived for a while. Make sure you check your credit score and report to see where you are after a decision has been made with your lender or the bank. When you are aware of your credit score, try to repay all of your debts and practice responsible credit behavior. Within the following 12 to 24 months, this will raise your credit score.