Does Loan Settlement Affect Your Credit Score?

can loan settlement reduce your credit score

Credit Score Settlement Reduce

Your credit score is the first and foremost thing that a lender will check when you apply for a loan. And once you get your personal loan, you have to repay your loan on time to avoid harming your credit score. However, sometimes due to unavoidable circumstances, you may be unable to repay your loan. It can be due to a financial crisis, accident, illness,  sudden loss of job, etc. In such cases, when you talk to your lender about your critical situation, they may give you the option to settle the loan. But did you know that settling your loan will harm your credit score? In this article, we will look at what is a Loan Settlement and how it affects your credit score.

By the end of this article, you will also get an idea of alternate steps instead of loan settlement. 

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What is Loan Settlement?

Loan Settlement is the process of negotiating and coming to a common agreement with your lender to “Settle” the loan by repaying only a small percentage of the loan amount to close the debt. This amount is usually lesser than the amount that you originally borrowed. Lenders will give you this option of One-Time Settlement only if you are genuinely unable to repay the loan such as financial hardship, accident, illness, loss of job, etc.

Loan Settlement Process

  1. Once the lender agrees to a One-Time Settlement, he will offer a 6-month non-repayment period. However, this option will be provided only if you agree to settle the loan in one payment. 
  2. The lender will then discuss with the borrower the seriousness of his/her situation and decide to write off the difference between the amount that has been repaid and the amount that is due.
  3. The lender may also waive the penalty for delayed payment and processing fee as a part of the principal amount depending on the genuineness of your issue. 
  4. Once the loan settlement process is complete, the lender will then close the loan and mark it as “Settled” which will be reflected in your credit report. 

Difference Between Loan Settlement and Closing the Loan

People often misunderstand Personal Loan Settlement with Closing the loan which is not true. Both are two different things. Here is the main difference between loan settlement and closing the loan. 

  • Loan Settlement: When you choose to settle your loan, you do not make your repayment throughout your loan tenure. This will often indicate to your lenders and the credit bureaus that you are not a reliable borrower and will also reduce your credit score.
  • Closing the loan: When you close your loan, you repay all your due amount completely throughout your loan tenure. This will indicate to your lenders that you are a responsible borrower and will in turn increase your credit score. 

Therefore, both loan settlement and closing the loan have different impacts on your credit score and your credit history. 

Effect of Loan Settlement on your Credit Score

  • The first thing that a lender does after the loan settlement process is close the loan and report it as “Settled” to the credit bureaus. So even if your loan comes to an end, it will not be the usual closure. 
  • Loan settlement will have a negative impact on your credit score because the status of “Settled Debt” will stay on your credit report for as long as 7 years. As a result, it will not only reduce your credit score but also indicate that you were unable to repay your loan. 
  • When you apply for any loans in the future, lenders will not be ready to offer you a loan as you will be perceived as a high-risk borrower and will not trust your repayment capability. 
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Alternate Options for Loan Settlement

You may see the loan settlement as an opportunity to close the loan account with a lesser amount. However, you may not be aware of the consequences of such a settlement. Because one wrong step can bother you for about seven years (as long as the credit bureau holds the information in its repository). So unless you don’t have any other option, do not choose the one-time loan settlement option offered by lenders. Here are a few alternatives that you can follow instead of settling your loan:

  • Use your investments or assets to repay your loan:

    If possible, try to liquidate your savings or investments to repay the outstanding loan amount in full. Also, think of other methods to raise funds to close the loan account.

  • Request your lender to increase your loan tenure:

    If you are having any issues repaying the loan, you can try and request your lender to either increase your loan repayment tenure, re-evaluate the monthly EMI structure, reduce the interest rate, or at least waive off the interest as long as possible. If your lender accepts the deal, make sure to verify the changes on your credit report and credit score. And maintain a good credit score by repaying your revised loan on time.

  • Take Insurance against your loan:

    You can also apply for an insurance policy against your loan. So if in case you come across a difficult situation where you are unable to repay the loan, your insurance will come in handy for you. Therefore, your chances of defaulting on your loan are reduced and do not affect your credit score any further.

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How to Remove Loan Settlement Status from your Credit Report?

First of all, do not choose loan settlement at any cost unless you don’t have any other option. If you have a genuine problem where you are unable to repay the loan, talk to your lender. Sometimes, they may agree to give you a payment break depending on how serious and genuine your problem is. And once that period is over, you have to start making the repayments. This completely depends on the lender, hence, talk about your financial problems to your lender before you consider opting for a “loan settlement”. 

Suppose you had no option but to choose “loan settlement”, your credit score will definitely be affected. This will also affect you when you are applying for any type of loan in the future. So if you want to remove the “Settled” status of loan settlement from your credit report, you have to talk to your lender and pay off all the unpaid debt. Also, ask your lender to provide you with a “No Dues Certificate”. Once you repay the balance debt, the lender will then report it to the credit bureaus and your credit score will improve. 

Always remember that lenders and banks will refuse to provide you with a loan if the credit history indicates that your debt has not been repaid. Keep in mind that loan settlement is not the best solution. Lenders may offer you a loan settlement because they know you will not be able to repay the loan, so they agree will to accept whatever you can pay to manage the loss at hand. 

So instead of choosing a loan settlement, you can follow the below-mentioned tips to avoid getting loan settlement status in your credit report:

  • First, try to repay your loan by liquidating your investments such as Mutual Funds, Fixed Deposits, or any other assets
  • Request your lender for an extension of your loan repayment tenure
  • If you have multiple loans to repay, try to consolidate them by getting a low-interest debt consolidation loan.
  • Apply for a mortgage loan or secured loan by pledging your assets such as gold, properties, etc., and pay off the current debt
  • Always keep an emergency fund to use in situations like this.
  • Please keep in mind that the loan settlement option must be considered only when you don’t have any other options left.

Therefore, if you choose a personal loan defaulter settlement, it will negate the original loan agreement between you and your lender. Also, if your lender reports the same to the credit bureau as ‘settled’ instead of ‘paid as agreed’ or ‘paid in full,’  it will have a detrimental impact on your credit score, and will in turn discourage other lenders from lending you loans in the future.

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Things to Remember While Availing of a Loan

Whenever you apply for any type of loan, it is important to be a little cautious while to avoid problems related to your overall financial management. So remember to follow these points when applying for a loan: 

  • Apply for a loan and borrow a loan amount only as per your requirement and within your repayment ability.
  • Avoid applying for multiple loans unless you really need them.
  • Pay off your monthly EMIs on time and do not default on your loan.
  • Keep monitoring your credit Score at regular intervals using  Buddy Score to keep a track of your financial health. 
  • When you choose for loan settlement, don’t apply for another loan immediately. Wait until your credit score improves.
  • Focus on maintaining your savings so that you have enough funds for emergencies to cover your EMIs instead of opting for loan settlement

How to Improve Your Credit Score?

Banks or lenders are often unwilling to provide loans if you have a low credit score as it indicates that you have defaulted on your loan repayments in the past. Hence, you have to maintain a good credit score to increase your chances of receiving loans easily at low-interest rates. You can improve your credit history by implementing certain practices like

  • Pay your credit card bills and monthly EMIs on time without defaulting.
  • Pay off all your existing and pending debts and do not opt for loan settlement.
  • Do not apply for multiple loans at the same time.
  • Utilizing your loan responsibility without overspending
  • Monitor your credit reports regularly to identify any potential errors.

Also Read: Salaried And Still Worried About Instant Funds A Personal Loan Is Here To Save Your Day

Final Note: What you should remember?

It is recommended to borrow only within your repayment ability and as per your needs and requirement. Do not borrow more as you may find it challenging when repaying the loan. And remember that if you opt for the loan settlement option, your credit score will be drastically affected and the remark stays on your credit report for 7 years. This will in turn make it difficult for you to apply for a loan in the future as you will be seen as a high-risk borrower. So never choose it unless you are left with no other options. 

If you are looking for personal loans at affordable rates, you can easily apply using Buddy Loan. It is one of the largest loan aggregators in India that helps you in getting personal loans from top trusted lenders. Also, remember to check your credit score using Buddy Score before you apply for one. 

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Q. Can I Remove The Settlement Status From The Credit Report?
Yes, you can remove the settlement status from the credit report. If you had opted for loan settlement for your loan in the past, contact your lender first. And repay the unpaid debt and ask the lender to provide you a “No Objection Certificate”. After this, the lender will update it to the credit bureau. 

Q. How To Increase Credit Score After Loan Settlement?
The first thing you have to do to improve your credit score after a loan settlement is to repay all the unpaid debts that you have. Further, you can also repay your other debts on time to improve your credit score. The credit bureau will record all of your financial activities as and when it is reported by lenders and banks. And also, maintain your credit utilization ratio below 30% to see an improvement in your score. 

Q. How Long Does a Loan Settlement Stay on Your Credit Report?
The settlement status will stay on your credit report for 7 years and lenders and banks may deny offering any loan to you due to the status of the settlement. Or you may get loans at comparatively higher interest rates due to the high risk associated with you not paying back the loan. 

Q. Does a One-Time Settlement Affect Your Credit Score?
Yes. One-time loan settlement will affect your credit score. Therefore, you must avoid accepting a loan settlement offer from your lender or bank. It must always be your last option. So look for other alternatives to repay the loan rather than choosing a one-time settlement.