Does Loan Settlement Affect Your CIBIL Score

What Does Loan Settlement Mean?

Settling a loan can refer to the agreement between the borrower and the lender to settle the outstanding balance for a loan that is less than the original repayment amount. 

In such a case, the borrower and the lender negotiate a reduced amount to settle the loan, often as a lump sum, to consider it paid in full. While this may be the route out of necessity for certain borrowers, it should be noted that such acts of distress closure can influence their CIBIL scores negatively and may be viewed less favourably by future creditors. 

How Does a Lender Process Loan Settlement? 

If a borrower has turned delinquent for a time span of six months or more, the lender will presumably offer an OTS (One Time Settlement). The offer for an OTS is subject to the lender being convinced that the non-payment was due to a genuine hardship, such as financial losses in business or serious clinical issues, due to which the income was affected. The lender will define a particular total, so it is easier for the borrower to repay the credit in one go. When the payment is made, the credit line will be closed. However, note that such a settlement will get registered in your credit report, potentially reducing your credit score.   

Impact of Loan Settlement on Borrower’s CIBIL Score  

Settling a loan can have a negative impact on the borrower’s CIBIL score. When a borrower settles a loan, it means that they and their lender have reached an agreement to close the loan for an amount less than the total outstanding balance. This reflects negatively on their credit score because it indicates that they did not fully meet their original repayment obligations and often reduces their chances of securing loans in the future. 

It is essential to explore alternative options, such as restructuring the loan or working with the lender to establish a more manageable repayment plan, before opting for loan settlement to minimise the impact on your creditworthiness. 
 

Also Read: Tips to Increase Your CIBIL Score Above 800  

How Can a Borrower Avoid Loan Settlement? 

Borrowers might see 'loan settlement' as a chance to pay slightly less at present, to close their credit account. However, this can lower your credit score for a substantial period. It is advised that loan settlement should only be resorted to when the borrower really does not have another choice. In case the credit amount can be paid by reserve funds or reserve ventures, loan settlement should be avoided. 

Another option that the borrower can think about is discussing with your loan specialist to broaden your reimbursement terms. Together the loan specialist (representing the lender) and the borrower can rethink the schedule of repayment and decrease the financial cost of the loan as much as possible. The repayment can also be planned so as to defer the payment of interest amount, as long as possible and to primarily concentrate on repayment of the principal amount.   

With the loan specialist, the borrower can try to check the loan progression and plan it out in such a way that the borrower’s credit report and credit score are impacted the least. Yet another financial option is that the borrower can take credit instead of a loan. The loan can be insured so that in case of financial hardship the insurance contract can help with the repayment of the loan. Since technically the repayment of the instalments will not be delayed (that is they will be paid by the credit insurance on time), the credit score of the borrower will not be impacted. 

What Should a Borrower Keep in Mind?  

Borrowers should only avail of a loan or credit that they can repay comfortably and on time. Commitment/Credit reimbursement can appear to be a viable option for the borrower when the borrower cannot repay the instalments on time. The borrower should always remember that this option will always unfavourably impact their credit score. They should only go for this option when they are left with no other financial options.  

What to Ask before Settling a Loan Account? 

Before the borrower proceeds to settle the loan, they should request that the loan specialist closes the record (as opposed to settling it). Some lenders might offer exits to regular customers in times of financial stress.    

Additionally, borrowers should have evidence of the last instalment paid prior to closing the record. Request a 'no-contribution declaration' from the loan specialist. This will assist them with questioning any mistakes on the credit report filed by the loan specialist.  

Also Read: How to Remove a Settlement from My Credit Report?

How to Improve CIBIL Score after Loan Settlement?

Borrowers who opted to settle their loan may consider some of the steps offered below to improve their current CIBIL scores: 

• Make timely repayments
• Practice financial discipline 
• Clear all pending financial obligations
• Manage credit cards and use them only when essential 
• Apply for a secured and insured credit line
• Utilise credit carefully and keep the credit utilisation ratio low 
• Try avoiding unnecessary hard credit inquiries   

Also Read: Importance of CIBIL Score & Tips To Improve It 

Key Differences between Loan Settlement and Loan Closure