Loan Settlement And Its Effects On Your Credit Score

People take all kinds of loans—personal, business or gold loans, to name just three—to meet immediate as well as long-term financial needs, when they are falling short on money.

But oftentimes, a borrower is unable to repay a loan owing to illness, injury, job loss or any other reason that may have left him or her insolvent. In such a situation, they may choose to go in for a loan settlement.

What Exactly Is A Loan Settlement?

A loan settlement is different from a loan closure, in which the loan is fully repaid along with the interest, and is therefore closed.

In a loan settlement, the borrower tells the lender that they are unable to repay the loan owing to difficult circumstances and asks the lender to give them some time off before they begin repayments.

The lender could give the borrower a one-time option of settling the loan in one go, after they have taken some time off. Once the repayments have been made, the status of the loan is considered to have been “settled.”

Lender’s Risk

A lender needs to be convinced that the borrower has a genuine need for a loan settlement. In such a case, the borrower may be given a non-repayment window of up to six months to settle the loan. Moreover, the lender may also write off a certain amount off the principal, so as to make it easier for the borrower repay the rest of the loan and interest.

The amount written off depends on the gravity of the situation that the borrower may be facing and his or her repayment capabilities. So, the loan will effectively be considered “settled” at an amount lower than the actual loan amount. The loan would have been considered “closed” had the borrower repaid the principal amount as well as the interest completely.

Impact on Credit Score

When a loan is “closed” the impact on the borrower’s credit score is positive, and as a result of that, the CIBIL score improves over time.

On the other hand, the moment a lender decides to write off a loan, credit information agencies are informed. Although the loan does come to an end, it has been “settled” and not “closed” and to that extent, it is seen as negative credit behaviour by the agencies and so, can have a negative bearing on one’s CIBIL score.

Put simply, a loan settlement can lead to a drop in one’s credit score. This information is held by such agencies for a period of seven years. If in that period, the borrower does wish to avail of another loan, the application may even be rejected if lenders are not sure of their capacity to repay.

Borrowers should, therefore, look at a loan closure only as an opportunity to pay less than the original amount, for the closure of the loan account. They should, however, be aware that a settlement will impact their credit history and could have long-term consequences.

Ideally, borrowers should try as much as possible to pay off the loan in full so that their credit history is not impacted. But if they must strike a settlement deal with the lender, they should make sure that they are aware of the way the same will impact their credit history.

To avoid any further drop in their credit scores, borrowers should go in for secured loans that are collateralised and in which, in case of a default, the lender can take over the pledged asset in lieu of the unpaid portion of the loan and interest.

Conclusion

While a loan settlement does help in closing a loan account by repaying less than the amount that had been borrowed, it does have a negative impact on your CIBIL score.

Moreover, as a borrower you should also ensure that you always choose a reputed lender like IIFL Finance. Doing this will not only get you the best deal possible in terms of the interest rates and other costs, but also when it comes to repaying your loan. IIFL Finance makes the entire process—from application to repayment—a hassle-free affair for the borrower.

And if you must go in for a loan settlement, IIFL executives will help you in making the entire process as smooth and quick as possible.