Do you have a loan, or are you planning to take one? You might have come across the term ‘loan settlement’. It is generally a preferred approach to pay back the loan and waive the burden. But do you wonder if it is the best approach?
The loans serve monetary needs on the spot. In return, borrowers are supposed to pay it back within a limited time period and based on a decided rate of interest. However, the regular payments can be skipped due to unavoidable circumstances leading to outstanding balances. What should be the right thing to do in such cases to avoid the negative impact on the CIBIL score? This insightful article will answer your questions about such scenarios. Review the same!
Understanding Loan Settlement
Loan settlement refers to completing the payment based on a mutual decision between the lender and borrower. It is done under difficult or special situations, which include loss of employment, accident or illness. The lender, on knowing the happening of such an event, can ‘settle’ the amount that will be less than the total outstanding debt. The borrower may get the additional time to settle the amount and begin repayments or be offered to pay back as a ‘one-time settlement’. The status of paying back the outstanding debts is displayed as ‘settled’ on credit reports.
Process of Loan Settlement
They process the difficult situations providing the inability of borrowers to lenders in the following manner:
- Assessment: The lenders verify the borrower’s problems and capacity, indicating their inability to pay the loan. If verified, lenders choose from two options: a non-repayment period or a settlement agreement.
- Non-Repayment Period: The lender can offer a non-repayment period that ranges from around six months. It offers relief to borrowers from making regular payments to clear the loan.
- Settlement Agreement: It refers to a ‘one-time settlement’ where borrowers are expected to pay a specific amount once. It is decided mutually and is generally less than outstanding debt in total.
- Loan Status: The timely update of information to CIBIL includes indicating the borrower’s status of the loan. It takes place once the reduced amount is paid to the lender. In this circumstance, the loan is marked as ‘settled, ‘ which is interpreted as the loan being resolved through mutual decision and negotiation. It affects the CIBIL score. You can perform a CIBIL Score check free anytime using the CIBIL Score app.
Impact of Loan Settlement on Credit Score
As a borrower, you might wonder about the impact of loan settlement on credit scores. It is pretty negative. Here are the categories of impact of loan settlement:
- Credit score: The loan settlement lowers your credit score based on the timely information updated by banks to CIBIL. For CIBIL Score, check free anytime using the CIBIL Score app.
- Duration on credit report: The status ‘settled’ is displayed on the credit report and remains for as long as 7 years.
- New Loan: Since some of the debt is waived off, the status is interpreted by the new and potential lender as the borrower’s inability to pay the loan on time, which is questionable on request for a new loan. The borrower will be offered high interest rates and longer terms.
Alternative Options for Borrower
A waive-off in the loan amount is a preferable option due to financial burdens on the borrower. However, the impact of a lower credit score and 7 years of ‘settled’ status on a credit report is worse. Choosing an alternative option is generally recommended to avoid ending up in the second situation. If possible, borrowers must choose from the following alternative approaches:
- Liquidate the investments or savings.
- Request additional time to repay the loan or extend the repayment term
- Modify the monthly installment structure for affordable monthly payments
- Modify or reduce the interest rate
- Waive off the interest for certain time period
If you have chosen the loan settlement option from the lender, then you must pay off the remaining amount as soon as possible. It will assist in improving the credit score. Additionally, do not forget to take the ‘No Dues Certificate.’
Remember to enquire about the effect of your alternative option on your credit score and report. We recommend performing the CIBIL Score check free regularly using the CIBIL Score app. For individuals who have not yet taken the loan but plan to, make sure to do any of the following things:
- Choose the secured loan over the unsecured loan
- Take the insurance policy
Conclusion
Accumulation of debts leads to a burden on borrowers. They want to settle or close the loan as soon as possible. Loan settlement is generally an option recommended by lenders to settle outstanding debts while considering the time and financial help of the borrower. It is applicable in certain situations of emergency. However, the impact on credit scores is negative, along with the effects on new loans. Borrowers should look for alternative options listed above rather than choose the loan settlement option.