Loan Settlement And Your Credit Score

What is a Loan Settlement?

A loan settlement is a phenomenon where a person who is unable to pay the loan amount, tries achieving a situation of compromise with the lender. An amount is negotiated upon and the borrower is relieved of the loan after that amount has been paid.

How does a loan settlement affect one’s credit score?

Loan settlement can be a good avenue to get rid of a loan if you are in an extreme financial crisis but there are a few cons also associated with it. Here are the pros that a loan settlement has-

Pros of loan settlement-

  • Lower your loan amount

    The actual amount that you have to pay can be reduced significantly if you settle a loan. This means that you can get rid of the loan before the tenure of the loan and pay a lower amount as well.

  • Avoid bankruptcy

    A bankruptcy is when you declare that you do not have the funds for repaying the loans in your name. Going for a loan settlement can help you avoid that situation. You can settle a loan if you feel you may go bankrupt.

  • Avoid creditors and collectors

    Creditors and collectors are people whose sole job is to extract money from borrowers for people who the money is owed and these people will not stop until that happens. Going for a loan settlement can also help you in avoiding creditors and collectors.

Impact of loan settlement on credit score-

Credit bureaus collect the record of all your credit and loan repayments every month. The type of information collected by these credit bureaus are-

  • If the payments are on time or late: If you are paying your EMIs and credit card bills on time i.e. before the due date mentioned on your statement.
  • Whether the account is closed: Even closed accounts will appear on your credit report for some time after the account is closed.
  • Other details about your financial history.

A loan for which the EMI payment is due for more than 90 days is registered as a non-performing asset by the bank. After 180-270 days past the payment date, the bank will write-off the loan. That is the loan will be settled. This settlement can happen before or after the bank writes-off the loan.

  • If the settlement had happened before the write-off: The credit report will be updated as “settled”.
  • If the settlement happens after the write-off: The credit report will be updated as “post-write-off settled”.

Under both of the aforementioned conditions, your credit score will be adversely affected. Also, you will be considered as a risky borrower by banks and NBFCs. They will shy away from giving you a loan in the future and your loan applicant is highly likely to be rejected.

Do not forget to collect a no-dues certificate from your borrower if you do opt for a loan settlement. This is important to ensure that no interest is accrued on the outstanding amount. That is the amount that was not paid for settlement.

How Long Will a Debt Settlement Affect Your Credit Score?

Who negotiates the debt settlement with your creditors determines how long a loan settlement will affect your credit score. If you are the one who is negotiating the loan settlement yourself, or if you choose to pay a for-profit company and use its services for loan settlement, your credit report shall contain the loan notation for 6-7 years from the date the payment of your loan settlement is processed, depending on the credit bureau. Even though it affects your credit score a lot in the early years, the impact eventually reduces as time passes.

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How To Improve Credit Score After Loan Settlement?

  • Convert ‘Settled’ to ‘Closed’ status: Talk to your credit company and request them to allow you to change the account status as closed instead of settled which has a greater negative impact on your credit score.
  • Make your payments regular: Your credit score is hit but now you really need to make your payments regular if you wish to bring your credit record back on track. Pay your bills in full and on time so that you can build your credit score again.
  • Maintain credit utilization: At any point in time, do not exceed more than 50% of your credit limit. This will help you in improving your credit score. This will also get you a higher credit limit in the future.
  • Use credit frequently: Do not stop using credit just because you have messed up once. Be responsible with the way you use credit and see how your credit score grows eventually.