Should you opt for loan settlement? What is the likely impact?

Umang Raheja (name changed) a 35-year-old software professional, had taken a personal loan of Rs 5 lakh to repair and refurbish his house five years ago. However soon after that he lost his job and was unemployed for a few months. During this period his father underwent emergency surgery. Umang was forced to dip into his savings for the medical expenses as well as for the regular household expenses. When he finally got another job, it was at a much lower salary. As he was unable to repay his personal loan due to his financial troubles, the interest payment and late payment fees added up. As Umang was unable to afford the EMI on his new salary, he decided to go for a ‘One Time Settlement’ of the loan with his bank.

Last year, Umang applied for a new credit card, but it was turned down. It was then that he realised the negative impact of the loan settlement on his credit score and credit record. Let us see what loan settlement means and under what circumstances you should go for it.

What is the meaning of loan settlement?

• A one-time loan settlement refers to an arrangement where the lender consents to receive a reduced sum compared to the full outstanding balance, consequently forgiving or eliminating the remaining debt.
• This type of settlement is typically considered by the bank under specific, legitimate circumstances, such as experiencing a loss of employment or facing a critical health situation.
• Generally, the bank might consent to this settlement after a predetermined duration, for example, a year.
• Following this agreement, the bank will officially conclude the loan account, and the individual will cease to be a borrower with that bank.

[Also Read: How To Improve Your Credit Score?]

What it means for the borrower

• In the bank’s records the status of the loan is closed, but in the credit bureaus’ records the status of the loan is ‘settled’.
• As against a ‘closed’ loan, a ‘settled’ loan is considered as negative behaviour by credit bureaus. This is because in case of a ‘loan closure’ the borrower repays the full amount, while in case of ‘loan settlement’ the borrower pays only a part of the amount.
• This will bring down your credit score and adversely impact your credit history. It takes up to seven years for a negative remark to be cleared off from an individual’s credit history.
• It could be tough for you to borrow in future if you have settled a loan in the past. Often you may not even realise this until you apply for a new loan or credit card.

What should you do

• Try to repay the loan as far as possible. Request your bank to extend your loan tenure or opt for debt consolidation, where you can transfer your loan to another loan with a lower interest rate. Or liquidate some investment (FD, MF) or pledge financial assets (Gold/MFs/Insurance/Stocks) and take a secured loan at a lower rate.
• If you have no option but to go for a One Time Settlement then ensure that till your credit score is restored, you don’t apply for a new loan. Every loan/credit application you make and gets rejected has a further negative impact on your credit score.
• Build up your savings so that in case of an emergency, such as job loss, you have enough funds to cover your EMIs. This will help avoid negative remarks in your credit record.

Disclaimer: This article is for information purpose only. The views expressed in this article are personal and do not necessarily constitute the views of Axis Bank Ltd. and its employees. Axis Bank Ltd. and/or the author shall not be responsible for any direct / indirect loss or liability incurred by the reader for taking any financial decisions based on the contents and information. Please consult your financial advisor before making any financial decision.