Are you having difficulty repaying your loan on time? Can’t meet your repayment obligations? Do you intend to seek a loan settlement with your lender? Does your lender offer you the option of a single settlement?
If you are looking to settle your debt with your creditors to free yourself from the cycle of late fees and missed payments, then reconsider!
Although you may end up paying less than you originally owed on the account, settling the debt can wreak havoc on your credit score, with repercussions that could linger for years. So before you consider “paying off” your debt, learn what it means and how it will affect your credit score.
How is loan settlement different from loan closing?
In layman’s language, the terms “loan settlement” and “loan closing” are frequently used interchangeably. However, loan settlement is diametrically opposed to loan closing. When a borrower pays all their monthly installments on time and repays the loan in full within the specified time, the lender closes the account. This is called the “closing of the loan”. Loan settlement, on the other hand, occurs when the borrower is unable to meet the loan repayment commitment due to unforeseen circumstances and settles the loan at a discount.
What is the loan settlement process?
If the lender is satisfied that the borrower is having difficulty repaying the loan due to circumstances such as illness, accident, job loss or any other reason, they will offer a single loan settlement option. During this debt settlement process, the debtor and the creditor agree to decrease the loan amount considered. The borrower makes a payment to the creditor on the condition that the remainder of the debt is forgiven, thereby marking the account as ‘settled’.
The status of the loan is thus marked as “closed” at the end of this negotiation agreement. And, once the total outstanding sum is cleared, the account is listed as “closed”.
Now, while this may offer temporary relief to the borrower, their credit rating is affected by this settlement and may even prevent them from taking out loans in the future. If the borrower had made the full payment, the loan would have been marked as “closed”. However, since it was settled, the settlement is considered negative credit behavior.
How does this affect credit score?
Once the loan is written off, the lender immediately reports it to the respective credit bureau like CIBIL, Experian, Equifax, CRIF High Mark. Since “settled” lending is seen as negative credit behavior, the entry stays in the borrower’s credit history for the next few years. years and will thus lead to a drop in the credit rating of 75 to 100 points, according to the bureau. Furthermore, it also makes it difficult for the individual to apply for new credit.
In other words, when the borrower applies for a loan in the future, when reviewing the application, the lender refers to their credit score and credit history and whether this reflects a “settlement loan”, the lender will be cautious and may even refuse to offer the loan.
Things borrowers should be aware of
- Always borrow within limits and make sure you have other ways to repay the loan. Banks and lenders know the borrower’s status well and only offer settlement because they are aware of the borrower’s inability to repay.
- A positive credit score is above 750, and when seeking settlement, the credit score is likely to fall below this threshold. This is reflected in the credit status, which may prevent the borrower from taking out a new loan in the next few years.
- Rather than being swayed by this option, if possible, consider liquidating a portion of your portfolio or other asset to waive the loan. Besides approaching friends and relatives, one can even ask the lender to extend the payback period while reducing or eliminating the interest rates for the time being.
- If the lender or bank approves, discuss the consequences and be sure to monitor your credit score frequently. You have to maintain a solid score and try to catch it when it drops.
- Always choose a secured loan over an unsecured loan. You can even opt for borrower insurance in case of doubt about your solvency.
How to improve credit rating after settlement?
- Regularize payments: Making all payments on time is the fastest way to boost your credit rating since it makes up one third of the overall credit rating.
- Maintain consistent card use: Try to lower the card usage ratios and bring it around 30% of the card limit.
- Reduce the debt ratio: It is necessary to try to repay and actively close the loans. This will reduce your leverage and give a positive signal to the credit bureaus, which is likely to increase your credit score.
To avail the credit, one has to observe an extremely disciplined behavior, because the repayment of the loan is a huge responsibility. It is therefore always advisable to borrow within your means and to make sure to repay on time. Moreover, it is also important that while taking a loan, one should have a plan B in place or other alternative means for repayment of the loan. Finally, you should regularly monitor your credit rating and benefit from updates and personalized advice to improve your credit rating.
The opinions expressed above are those of the author.
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