Loan Settlement and Its Effects on Your Credit Score

Many mistake loan settlement for loan closure, but they are not the same. Loan closure occurs when you repay your EMIs on time and clear the full loan amount. The lender updates this with credit bureaus, potentially boosting your credit score.

But how does loan settlement differ, and how does it impact your creditworthiness? Read on to find out! 

What does loan settlement mean?

Loan settlement happens when you’re unable to repay your loan due to reasons like illness, job loss, or financial hardship. In such cases, you request the lender for temporary relief.

The lender may offer a one-time settlement, allowing you some time before making a lump sum payment. Once settled, your credit report will mark the loan as ‘settled’, which can negatively impact your credit score.

How does a lender process this?

If your lender finds your financial hardship genuine, they may offer a 6-month non-repayment period with a one-time settlement option. This means the lender writes off a portion of the loan, making it easier for you to repay.

However, since the settlement amount is lower than the outstanding balance, the loan is marked as ‘settled’ instead of ‘closed’. Unlike a closed loan, a settled loan can negatively impact your credit score and future loan eligibility.

How does loan settlement impact your credit score?

When a lender writes off a loan, they immediately report it to CIBIL and other credit bureaus. While the loan is settled, it is not considered a proper closure. Instead, it is marked as ‘settled’, signaling negative credit behavior to future lenders.

This results in a drop in credit score, and the record remains for seven years. During this period, securing new loans can be challenging, as lenders may doubt your repayment capability or even reject your loan application outright.

How can borrowers deal with this?

A loan write-off may seem like an easy way to pay less, but many borrowers overlook its long-term consequences. Since credit bureaus retain this record for seven years, a single settlement decision can impact your financial future.

Unless you have no other option, avoid settling a loan. Instead, consider:
✅ Liquidating savings or investments to repay in full.
✅ Exploring alternative ways to raise funds.
✅ Negotiating with your lender for an extended tenure, lower EMIs, reduced interest rates, or an interest waiver.

Settlement should always be the last resort. Closing the loan properly ensures a better credit score and future loan eligibility.

Once you strike a deal with the lender, make sure to verify the changes that happen on your credit report and credit score. Maintain a good credit score and behaviour, and try to make up for any dip in your score. To further avoid such situations, you can go for a secured loan rather than an unsecured one so the lender will not have to be wary of your repayment capabilities. 

Alternatively, you can also take an insurance policy against the loan. In this case, even if you come across a tough situation where you cannot repay, the insurance does the needful for you. Therefore, you will not default on payments and it won’t affect your credit score.

What you should remember?

• Borrow within your repayment capability and as per your requirement. Do not get greedy and borrow more as you will find it difficult when repaying.
• The main reason why a one-time settlement option is provided is that the lender will be sure that you are unable to repay the loan; they would want to close the transaction with whatever you can pay. So, they would want to finish the deal with whatever they can get from you.
• Your credit score will drop considerably with a status of ‘settled’. This will make it hard for you to get any loans in the future.

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