Loans are an integral part of modern financial life. They help individuals achieve their goals, whether it's buying a home, pursuing higher education, or starting a business. However, life is unpredictable, and financial challenges can arise unexpectedly, making it difficult to repay loans as initially agreed upon. In such situations, borrowers often find themselves facing the possibility of loan settlement. But what exactly is loan settlement, and how does it affect your credit score? Read on to learn more about the process and its impact on your credit score.
What Is Loan Settlement?
Loan settlement is a process that occurs when a borrower cannot repay a loan as per the original terms and conditions. In this scenario, the lender may offer the borrower the option to make a one-time payment to settle the loan account. The settlement amount is typically lower than the total outstanding loan balance. However, it is important to note that loan settlement is usually followed by a non-repayment period during which the borrower is not required to make regular payments.
Example of Loan Settlement
Take the example of Kumar, who took out a personal loan with a repayment period of five years. Unfortunately, two years into the loan term, Kumar lost his job. After being unemployed for six months, he eventually found new employment but at a much lower salary than what he had. With his reduced income, Kumar realized that he could no longer afford the monthly loan repayments. In this challenging situation, Kumar approached the lender to discuss the possibility of settling the loan.
After carefully assessing Kumar's financial circumstances, the lender offered him a one-time settlement amount that he could pay to close the loan. Kumar decided to accept the lender's offer and made the reduced payment, effectively settling the loan.
How does a lender process Loan Settlement?
The process of loan settlement is not standardized and may vary from one lender to another. The settlement amount is typically determined at the discretion of the lender, taking into account various factors such as the loan amount, the amount repaid to date, and the reasons provided by the borrower for seeking a settlement. Lenders may offer different settlement amounts to different borrowers based on their unique situations.
If the lender believes that the borrower's reasons for non-repayment are genuine, they may agree to write off a portion of the loan amount in order to facilitate the settlement. However, it's important to note that a lender will generally agree to a loan settlement only if the borrower commits to making the settlement payment in a single lump sum. Additionally, the lender may specify a non-repayment period during which the borrower is not obligated to make any payments.
Despite settling the loan, the status of such loans is often marked as 'settled' in the lender's records instead of 'closed.'
How does Loan Settlement impact your credit score?
Loan disbursements and their subsequent repayment with interest are crucial sources of income for lenders. Consequently, when a loan settlement agreement is reached, it can have an impact on the lender's financial performance. This impact is also reflected in the borrower's credit score.
Credit rating agencies, such as CIBILTM (Credit Information Bureau (India) Limited), consider loan settlement to be a negative financial behaviour on the part of the borrower. When a borrower successfully negotiates a loan settlement with the lender, the lender typically reports this information to credit rating agencies. This reporting triggers a series of actions:
- The agency marks the transaction as 'settled': This information is shared with other credit rating agencies, making it visible across the board.
- The borrower is flagged as unsuitable or risky for credit: Due to the settlement, the borrower's creditworthiness is deemed lower, resulting in a drop in the individual's credit score.
It's important to note that all credit rating agencies retain this information in their records for up to seven years. During this period, borrowers who have settled loans may find it challenging to obtain new loans, credit cards, or any other forms of credit. Lenders may reject their applications, viewing them as potentially incapable of completing full loan repayments.
Can you remove Loan Settlement status from your credit report?
If you've settled a loan in the past and are concerned about the impact on your credit score, you can take the below steps to improve your creditworthiness. Here's what you can do:
1. Avoid Loan Settlement whenever possible: The best course of action is to avoid loan settlement altogether. If you find yourself facing financial difficulties, it's advisable to communicate with your lender early on. Lenders may offer solutions, such as a temporary payment break or a revised repayment plan, to help you manage your financial challenges without resorting to settlement.
2. Pay off the outstanding debt: If you have already settled a loan and want to remove the 'settled' status from your credit report, consider paying off the remaining outstanding debt. Reach out to your lender and inquire about the possibility of settling the debt in full. Once the balance is paid, ask your lender for a 'No Dues Certificate.' This certificate signifies that you have cleared all your dues, and the lender will report this to credit bureaus and remove the settled status. Your credit score is likely to improve once this process is complete.
It's important to note that lenders and banks may hesitate to extend credit to individuals whose credit score indicates that they have not fulfilled their past financial obligations. Therefore, maintaining a positive credit history by making timely repayments and avoiding loan settlements is crucial for your financial health.
FAQs on Loan Settlement and its impact on credit score
1. Can I remove a loan settlement from my CIBILTM report?
Yes, you can potentially remove the status of loan settlement from your CIBILTM report. To do this, pay off the unpaid debt in full and obtain a 'No Objection Certificate' from your lender. Additionally, you can raise a dispute on the CIBIL website, providing all necessary documents as proof of complete debt repayment. The dispute resolution process may take 30-45 days, after which the settlement status should be revised.
2. Does closing a loan increase my CIBILTM Score?
If you have consistently made all your loan repayments on time, closing a loan can have a positive impact on your CIBILTM score. Closing a loan on time signals to lenders that you are a responsible borrower who has successfully managed to repay all debts as agreed upon.
3. How can I increase my CIBILTM score after a loan settlement?
To improve your CIBILTM score after settling a loan, consider the following steps:
- Repay any remaining unpaid debt associated with the settled loan.
- Continue making timely repayments on other outstanding debts.
- Maintain a low credit utilization ratio (below 35%).
- Keep in mind that your credit score is dynamic and can change based on your financial behavior over time.
4. How long does a loan settlement stay on my CIBILTM report?
A loan settlement status remains on your CIBILTM report for seven years. During this period, you may encounter challenges in obtaining new credit, and if approved, it may come with higher interest rates due to the perceived risk associated with your repayment history.
5. Does one-time settlement affect my CIBILTM score?
Yes, a one-time loan settlement can have a negative impact on your CIBILTM score. It's crucial to approach loan settlement as a last resort and explore alternatives to repay the loan in full whenever possible. Settlement should be considered when no other viable options are available.