Loan Settlement: Procedure, Impact on Credit Score

When you apply for a loan, it's important to be aware of your loan repayment capacity. In case you are unable to repay your loan due to unavoidable circumstances, then one of the options available is loan settlement.

However, this is not a recommended option due to various reasons, one of which includes the adverse impact on your credit score.

What is Loan Settlement Process

Personal loan settlement process, also known as personal loan defaulter settlement refers to an agreement between a lender and a borrower wherein the loan is ‘settled’ by repaying only a part of the loan.

  • The lender may forgive a part of the debt in order to help the borrower repay the loan at least partially.
  • This option is only available if the borrower has a genuine reason for being unable to repay such as a serious injury, medical emergencies, loss of a job,etc.

Based on the number of EMIs that have been unpaid, a lender may agree to waive the processing fee or penalty for delayed payment or in extreme cases, a part of the principal amount. As mentioned previously, this will depend on the borrower’s reason for defaulting as well as the amount that is yet to be repaid.

Once the loan settlement process is completed, the lender will close the loan and mark it as ‘settled’.

Should You Opt for Loan Settlement?

No! Not unless there is absolutely no other option. At first glance, loan settlement may look like an easy way out of not repaying the loan, but the consequences are detrimental. This is the case for all loans, including personal loans.

Instead of opting for a personal loan settlement process (or any other loan), try to go for some of the options given below-

  • Try to repay the loan by liquidating your investments like Mutual Funds, Fixed Deposits, or any other assets
  • Request for an extension of your loan tenure
  • If you have multiple loans running, try to consolidate them into a low interest debt-consolidation loan
  • Opt for a mortgage loan or secured loan by pledging financial assets like gold, properties, etc., and pay off the current debt
  • Always have an emergency fund that can be used in situations like this

Please bear in mind that going for a loan settlement process should be considered only when you have exhausted all other options.

When you opt for a personal loan defaulter settlement, it negates the original credit agreement between you and your lender. Also, when your lender reports the same to credit rating agencies as ‘ settled’ instead of ‘paid as agreed’ or ‘paid in full’- it will have a negative impact on your credit score, and discourage other lenders from lending you credit in the future.

Impact of Loan Settlement Process on Your Credit Score

Did you know that settling a loan may hurt your credit?

  • Loan settlement process can negatively affect your credit history and reduce your credit score drastically thereby limiting your chances of receiving credit in the future.
  • When you opt for a loan settlement, even if it is for a genuine reason, the amount paid will be lesser than the original amount which reduces your creditworthiness.

While the loan might have been ‘closed’, your name may be on the list of loan defaulters. Besides, your lender will report the same as ‘settled’ to the credit bureaus which has a detrimental impact on your credit score.

You will be considered as a risky borrower which will prevent lenders from providing loans to you easily.

How Does Loan Settlement Impact the Borrower

The very act of opting for loan settlement has a negative impact on his/her credit score. A ‘settled’ loan is considered as negative behavior by credit rating agencies as the borrower has failed to repay the entire loan amount which brings down his/her creditworthiness.

Borrowing for such individuals will be very hard in the future and even if they do avail a loan, it will be at very high interest rates or other unfavourable conditions. For a borrower, it takes nearly seven years or so to reestablish a positive score and improve his/her credit history.

Difference Between Loan Settlement and Loan Closure

Loan closure is a term that refers to the closing of an existing loan account after the borrower repays the loan fully on time. This will have a positive impact on one’s credit score.

On the other hand, loan settlement refers to the process of a lender forgiving a part of the borrower’s loan amount in order to help the borrower repay the loan. Although the loan account is technically closed, since the amount was not fully repaid, this process will have a negative impact on the borrower’s creditworthiness and future borrowing prospects.

Things to Remember While Availing a Loan

Being a little cautious while opting for credit will help you avoid multiple problems related to your overall financial management. It’s important to keep in mind the following points -

  • Apply for credit carefully. Borrow as per your requirement and within your repayment capability
  • Avoid taking multiple credit cards or loans unless you really need to
  • Pay off your monthly EMIs on time
  • Keep monitoring your CIBIL Score at regular intervals to keep a track of your financial performance
  • When you opt for loan settlement, don’t apply for a new loan immediately. Waiting until your credit score increases is recommended
  • Focus on building up your savings so that you have enough funds to cover your EMIs in emergency situations instead of opting for loan settlement

How to Improve Your Credit Score?

A low credit score always exposes a lender to a high risk of default. Therefore, banks or lenders are often unwilling to offer credits to individuals who have a low credit score and who have defaulted on loan payments in the past.

Hence it is very important to maintain a good CIBIL score to increase your chances of receiving credit easily at reasonable rates. You can build up a good credit history by practicing the following –

  • Paying credit card bills and monthly EMIs on time without defaulting
  • Paying off all your existing debts without opting for loan settlement
  • Not applying for multiple credits at the same time
  • Utilizing your credit responsibility without overspending
  • Monitoring credit reports regularly to identify discrepancies, if any

Here are some other steps you can take to increase your credit score.

To know more about your credit score and the impact of the same on your finances, check out our extensive article on this.

In Conclusion

Opting for loan settlement may seem like an easy way out if you are unable to repay your loan on time but bear in mind that a loan settlement process will have a severe impact on your credit score. Additionally, you may not be able to avail loans in the future affordably. Settle your loan only if you have no other option.

One way to prevent this entire situation is to avail affordable loans and an amount that you are confident of repaying. If you are looking for instant online personal loans at competitive rates, visit the Money View website or download the loans app to apply today.