Loan Settlement and Its Impact  on Your Credit Score

Borrowers frequently believe that ‘loan settlement’ and ‘loan closure’ are synonymous. Not only are they different, but they also have an opposite impact on your credit score. If you plan to ask your lender for a loan settlement, doing so might result in you paying less overall. However, it will negatively impact your credit score. Therefore, you must understand what a loan settlement means and how it may affect your credit score.      

Understanding Loan Settlement 

A loan settlement is an agreement between a lender and a borrower where the outstanding loan amount is settled by refunding only a portion of the credit balance. Here the lender absolves some part of the loan helping the borrower clear the loan partially. Further, the borrower can also ask for some time before they start making payments. 

For instance, you must have hatched out a repayment plan when you availed of a loan. However, due to an unforeseen crisis such as job loss, injury, illness, or other reasons, you find yourself unable to repay the debt as per agreement. In such a scenario, you can inform your lender about the crisis and request them to allow some time to make the payments in full. In short, you are asking your lender to “settle down” the loan.

Here your lender can provide you with a one-time settlement option while you can get some respite to clear the loan all at one go. The settled amount will be lower than the total amount of unpaid debt you have. The amount that will be written off depends on the severity of the scenario and your repayment capabilities. 

Subsequently, the status of this loan will be shown as ‘settled’ in your credit report and may remain for as long as seven years

Impact of Loan Settlement on Credit Score 

Whenever a lender settles a loan with any respective borrower, they instantly report it to the credit rating agencies. . Hence, credit rating agencies mark the transaction as ‘settled’ in the credit report. A ‘settled’ loan is viewed as a negative credit behaviour. Due to the settlement of the loan, the borrower’s credit score may drop down. As a result, lenders will be wary of the borrower seeking another loan during this period. In such instances, there is a potential that a loan application would get rejected.  

Also Read: CIBIL Credit Report: What Is Credit Score & How to Check Credit Score Online

How to Settle a Loan in India?

There are four key steps involved in settling a loan in India:

Step 1: Assess your financial situation

The initial phase of settling a loan involves analysing your financial position and checking if the loan settlement is appropriate for you. This step includes verifying your current income, assets, expenses, and debts. Moreover, you have to consider your financial goals too.

​​You need to be careful while accepting a loan settlement offer from your lender or bank. It should always be the last resort. Look for alternatives to repay the loan rather than opting for a one-time settlement. 

Step 2: Contacting your bank or a lender

After selecting the appropriate loan settlement option, contact your lender or financial institution. Here you have to reveal your financial status and the reason you want a settlement.

Step 3: Negotiate a settlement agreement

In the third step, you should negotiate a settlement agreement with your lender.  During negotiations, you should agree on a specified amount which is lesser than the amount you initially borrowed.

Step 4: Make the payment and close the loan

After you fulfil the agreement, the last step is to make the payment and settle the loan. Here you need to pay a lump sum to your lender. Upon loan settlement, you have no obligation left to make future payments. 

Merits of Loan Settlement

The following are the advantages of loan settlement:

• Helps avoid defaulting

Non-payment of your loan can lead to severe consequences involving a reduction in your credit score, seizing properties, a lawsuit by the lender, and so on. Settlement of loan will enable you to stay away from default and unwanted consequential hassle.   

• Lowering your payments

Making payments on time can be challenging, especially if you are in a financial crisis. Therefore, instead of struggling to make payments, you can opt for loan settlement since it reduces your burden by making it affordable.

Disadvantages of Loan Settlement

Even though one-time loan settlements offer borrowers quick relief from financial problems, it is not considered an ideal option since it affects the credit score in due course. Lenders need to report the settlement to the credit bureau, and your account status gets denoted as “settled”. This will mean that you have cleared your credit amount partially, and your credit score will be hampered. 

Instead of opting for a loan settlement, you should talk to your lender about your financial situation and ask for a payment break or holiday. This will provide you with some time to make the repayments. However, this completely depends on the lender, and it is not a guaranteed solution offered by every bank and lender. 

Also Read: Personal Loan for CIBIL Defaulter: Ways to Get Loan for CIBIL Defaulters

Final Word

Loan settlement is a great way to receive some relief and settle your loan by paying less than the amount outstanding in the event of a financial crisis. However, keep in mind that loan settlement hurts your credit score. So, weigh the benefits and drawbacks and make an informed decision. 

Frequently Asked Questions