Loan settlement and credit score

What Is Loan Settlement? How Does It Affect Your Credit Score?

When you borrow money, you may have a plan to repay in some time. But you may find yourself in a situation where you cannot meet your obligations. Banks and other lenders offer different loan settlementoptions that you may use to settle the loan. But you need to be careful while doing so, since a wrong loan settlement option may adversely impact your credit score. Let's see how:

The loansettlement process is often confused with ‘loan closure’. However, they are not the same. If you pay all your monthly instalments on time and complete the payment as scheduled, the lender will close the loan account; this is called 'loan closure'.

The same information will be sent to credit rating agencies and could have a positive impact on your credit scoreas you successfully repay the loan. There are times when you must borrow money to meet expenses that are unforeseen. You take out a personal loan from a financial institution like a bank with the thought of repaying it in equated monthly instalments (EMI) for a certain number of years.

Your bank may offer you a one-time option to repay the loan. The bank or lending institution will give you this option if you haven’t paid your EMI for 6 months. The other circumstances in which a bank may offer loan settlement are job loss, critical health conditions, etc.

The Loan Settlements Process Impacts The Credit Score Adversely

When a bank or lender is writing off a loan, they report it to CIBIL. Though the relationship between the lender and the borrower has been terminated, CIBIL doesn’t consider that. When a loan is termed settled, it is viewed as a negative credit behavior and the borrower’s credit score for personal loan drops by 75-100 points.

CIBIL retains a borrower’s record for more than 7 years.So, if the borrower needs a loan during that period, it is likely that the lenders will be wary of the borrower and avoid giving the borrower any loan. Banks and lenders primarily look at the borrower's past payments before giving a loan.

How Does The Lender Process This?

If the lender is convinced that your reason for default is reasonable, then it will agree toa loan settlement. This option will only be provided if you agree to repay the loan with a single payment. The lender will deduct a certain amount from the loan to make it easier for the borrower to repay the loan.

The amount to be deducted depends on the seriousness of the borrower and the ability to repay. As a result of this settlement, the amount is lesser than the actual remaining amount, the condition of the loan will be marked ‘complete’. Conversely, if the borrower had paid the remaining balance, the loan status would be recorded as 'closed'.

What Should You Remember?

Always try to live within your means and borrow the money you can easily repay on time.

Keep in mind that your credit score will decrease significantly if you choose the loan settlement option to close your loan. This will make it harder for you to qualify for any kind of loanin the future.

Consider any other possible ways to raise enough money to close a loan account. Additionally, you can try asking your lender to extend your repayment period, update your monthly installment plan to make it easier for you to pay monthly,

Once you have obtained an agreement with the lender, be sure to confirm the changes that take place in your credit report and credit score. Maintain a good credit score and try to fix your credit score. To avoid such situations again, you may want to take out a secured loan instead of an unsecured loan so that the lender does not suspect on your ability to repay.

Is There Any Solution For The Borrower?

For settling your loan, you could also look at other options, such as selling part of your property or stock. If not, you can talk to your bank or lender to review your payment terms to extend or restructure your monthly installments by reducing interest rates.

If your CIBIL score is already affected, you can improve it by paying the balance or cancelling your loan account and obtaining a No-Objection Certificate (NOC) from the lender and notifying the credit bureau on the CIBIL website. This will help to change the status of your loan account to be 'closed' to 'terminated'.

Final thoughts

It is highly recommended to borrow according to your repayment ability and not necessarily according to your need. Remember that borrowing is easy, but repaying is very difficult.

But from a borrower's point of view, this is not the most appropriate option as it may adversely affect your credit score. Lender’s view ‘adjusted’ as a negative comment that may question your ability to repay if you need another loan. Remember that a fixed comment may remain on your credit report for a period of seven years, thus making it harder to get a loan for seven years.

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