Loan settlement is frequently misunderstood as loan closure, but these terms carry distinct consequences for your credit score. Regular and timely monthly payments lead to the natural closure of a loan account upon complete repayment, positively influencing your credit score. In contrast, loan settlement arises when unforeseen circumstances prevent borrowers from making repayments, negatively impacting their credit score and future loan approvals.
What is Loan Settlement?
The Loan Settlement Process entails an agreement between a lender and a borrower whereby the loan is resolved by repaying only a portion of the total amount.
In this process, the lender may choose to forgive a portion of the debt to facilitate partial repayment by the borrower. This option is typically extended when the borrower can demonstrate genuine reasons for their inability to repay, such as severe injury, medical emergencies, or loss of employment.
The extent of concessions the lender offers, such as waiving processing fees or penalties for delayed payments or even forgiving a portion of the principal amount, depends on factors including the number of missed instalments and the borrower’s justification for defaulting.
Upon completion of the loan settlement process, the lender formally closes the loan account and marks it as ‘settled’.
Loan Settlement Process – How Loan Settlement Operates?
- Verification Process: Lenders confirm genuine reasons beyond the borrower’s control for defaults.
- Settlement Offer: The lender typically offers a one-time settlement, often at a reduced amount, taking into account the borrower’s ability to repay and the gravity of the circumstances.
- Payment and Closure: Upon settlement payment, the lender writes off the loan, closes the account, and reports it as “settled” to credit bureaus.
Impact of Loan Settlement on Credit Score
Accepting a settlement offer leads to a “settled” status on your credit report, viewed negatively by lenders. This event can slash 75 to 100 points from your credit score, posing challenges for future loan approvals for up to seven years.
Were you aware that settling a loan could harm your credit?
- The loan settlement process can negatively affect your credit history and drastically reduce your credit score, limiting your chances of receiving credit.
- When you opt for a loan settlement, even for a genuine reason, the amount paid will be less than the original amount, reducing your creditworthiness.
- Your name might still be listed among loan defaulters despite technically closing the loan. Moreover, your lender will report the settlement to credit bureaus as “settled,” further damaging your credit score.
- You will be considered a risky borrower, preventing lenders from providing loans to you quickly.
Should you opt for loan settlement?
Using it as a final option should be the case. While it might seem easy to avoid repaying the loan, the repercussions can be severe. This holds for all types of loans, including personal loans.
Instead of resorting to a personal loan settlement process (or any other loan settlement), consider the following alternatives:
- Liquidate your investments, such as Mutual Funds, Fixed Deposits, or other assets, to repay the loan.
- Request an extension of your loan tenure to reduce the monthly repayment burden.
- Consolidate multiple loans into a single, lower-interest debt-consolidation loan.
- Opt for a home or secured loan by leveraging assets like gold or properties to pay off existing debt.
- Maintain an emergency fund for unforeseen financial challenges.
Remember that opting for a loan settlement should only be considered after exploring all other options. When you settle a personal loan nullifies the original credit agreement with your lender.
Additionally, if the lender reports the settlement to credit rating agencies as “settled” rather than “paid as agreed” or “paid in full,” it can significantly impact your credit score and deter other lenders from extending credit to you in the future.
Alternatives to Loan Settlement
While a settlement may seem tempting due to reduced repayment, it’s a last-resort option. Explore these alternatives before considering loan settlement:
- Utilise Savings and Investments: Tap into personal savings or investments to settle outstanding amounts.
- Seek Assistance from Family and Friends: Borrowing from close circles can be an option to avoid settlement.
- Negotiate with Lender: Discuss restructuring options, such as reduced interest rates or extended repayment tenure with your lender.
- Opt for a Low-Interest Personal Loan: Consider a loan with lower interest rates to clear the outstanding amount.
Difference Between Loan Settlement And Loan Closure
The distinction between loan settlement and loan closure lies in how the loan is resolved and its impact on the borrower’s credit.
- Loan closure occurs when a borrower successfully repays the entire loan amount according to the terms and schedule outlined in the loan agreement. This reflects positively on the borrower’s credit history and contributes to a healthier credit score.
- In contrast, loan settlement involves the lender and borrower reaching an agreement where a portion of the loan amount is forgiven to facilitate repayment. While the loan account is closed, the fact that the total amount was not repaid can adversely affect the borrower’s creditworthiness. Settlements are often recorded on credit reports as “settled,” signalling to future creditors that the loan was not fully repaid as initially agreed upon.
In summary, loan closure signifies successful repayment of the loan amount, boosting creditworthiness. In contrast, loan settlement involves partial loan forgiveness, potentially negatively affecting the borrower’s credit score and borrowing prospects.
Final Words:
In conclusion, while a settlement might appear alluring with its reduced repayment terms, it should be approached cautiously, considering its detrimental impact on your credit score. Accepting a settlement offer marks your credit report negatively, making future loan approvals challenging. It’s crucial to exhaust all available alternatives before opting for a settlement.
Explore leveraging personal savings, seeking support from family and friends, negotiating with your lender for favourable terms, or considering low-interest personal loans. Each alternative aims to preserve your creditworthiness, ensuring a more secure financial future. Thus, before embracing a loan settlement, carefully assess its long-term consequences and prioritise strategies that protect your credit standing.