How does a loan settlement affect your CIBIL score?
A loan settlement can promptly impact an individual's CIBIL score, a crucial factor in determining one's creditworthiness.
When borrowers choose the path of settling a loan, it means they've reached an agreement with the lender to pay a portion of the outstanding debt, often less than the total due, to close the loan. This settlement, though seemingly resolving the debt, can have implications on the borrower's credit history and subsequently affect their CIBIL score. Understanding the degrees of how loan settlements influence this score is vital for individuals navigating their financial obligations and seeking to maintain a healthy credit profile.
What is CIBIL score?
The CIBIL score is a three-digit numerical representation of an individual's creditworthiness, based on their credit history.
The score typically ranges between 300 and 900, with a higher score indicating better creditworthiness. Lenders, such as banks and financial institutions, refer to the CIBIL score to assess the creditworthiness of borrowers before approving loans or credit cards.
What is loan settlement?
Loan/debt settlement is also termed to be known as credit settlement. It is a proposal where the lender and creditor come to a common understanding after the borrower demonstrates his/her inability to repay the loan due to unavoidable circumstances. The amount of loan is mutually agreed upon, which is less than the loan outstanding amount, and is get paid off by the borrower to the lender as a one-time payment.
Professional advice - You should opt for a loan settlement only when you have exhausted all other avenues of repaying the loan as the loan settlement affects your credit score negatively.
How does a lender process a loan settlement?
Here is an overview of how a lender typically processes a loan settlement,
Step 1 :
The process usually begins when the borrower approaches the lender expressing their inability to repay the loan in full and proposes a settlement.
Step 2 :
The lender may evaluate the borrower's financial status, including income, assets, liabilities, and reasons for the financial hardship.
Step 3 :
Then one settlement will take place that will have the amount decided from both the parties after assessing the borrower’s repayment capacity and the severity of the situation.
Step 4 :
Now, when both the parties agree on the decided terms of the settlement, a formal agreement will be designed. This agreement outlines the terms and conditions of the settlement.
Step 5 :
The borrower makes the agreed-upon payment as per the settlement terms. After receiving the payment, the lender marks the account as settled.
How does a Loan Settlement Affect Your CIBIL Score?
Whenever a lender decides to write off your loan, they immediately report the case to the credit bureaus.
Though the loan tenure comes to an end in the form of a settlement between the borrower and lender, it is still not considered as 'Closed' by credit bureaus, they term it as 'Settled'.
When a loan is termed settled, it is viewed as a negative credit behavior and the borrower’s credit score drops by significant points . If during this period, a borrower applies for any fresh credit, it might get difficult for the lenders to approve such applications or the loan will get rejected immediately due to records of settled loan.
How can borrowers deal with the problem?
Undoubtedly, loan settlement may feel like a golden opportunity to pay a minimal amount, but it should be considered as the fallback and borrowers should think of the options that could help them pay off the loan in full amount (taken) in any way possible, just to maintain the better credit health;
Option 1 - Borrowers can utilize their funds such as from fixed deposits or their savings accounts to pay off the outstanding loan amount in full.
Option 2 - The borrower can also insist the lender extend the period of repayment of the loan so that he/she can get some extra time to pay the amount in full.
Option 3 - If any case possible, the borrower shares a good relation with the
lender (Bank) and can try and request to waive off the interest amount on the loan to repay at least the principal component on time, and get their monthly installments restructured.
Professional advice : Also, going forward try to maintain good credit behavior and credit score and try to make up for any dip in your credit score. Never forget that your credit health matters!
What are Alternatives to Loan Settlement?
While loan settlement might seem like the primary solution to the problem, exploring alternative pathways to manage debt is always a wise decision.
- Try to utilize your savings tools (like fixed deposits, gold, mutual funds, stocks, etc.) to repay your loan as much as possible/or try to pay the whole amount.
- Try to sell off some of your assets to repay the loan.
- Level up your savings so that in case of an emergency, you have enough funds to repay your EMIs of loan.
Now if you are only left with the option of setting the loan, then avoid borrowing again till your settlement remark is removed from the credit report. It will tagged as settled account till the time waived off amount is paid back to lender
How to build CIBIL Score After Loan Settlement?
Rebuilding a CIBIL score after a loan settlement is critical to regaining financial credibility and access to future credit opportunities.
Here's a guide on how to build your CIBIL score after a loan settlement:
- Develop good history of credit
To analyze your loan eligibility the very first thing that will be observed is the income proof and your credit score.
In that concern, you have to develop a positive history and wipe out the negative history mentioned in the report and to do that make sure you pay all of your credit bills and EMIs on time.
- Pay off your dues on a regular basis
Your payback history is a major indicator of your credit health. Making timely payments will positively grow your credit history and is one of the most efficient ways to restore your credit score.
- Wave off any outstanding dues
Any loan, credit card, or EMI that stays unpaid has a significant impact on your credit score.
The longer you take to to pay the amount used, the more interest accrues, and you'll have to pay a considerably huge sum of amount to wave off debt and in all of that your credit score continues to decline as you delay payment, so never do that and be very prompt when it comes to waving off the bills of cards, loans etc.
- Apply for the card
Apply for a credit card if you do not already have one, by doing that you should be able to use credit even if you have a settled loan. Trying to get the most out of a credit card will definitely help you improve your credit score and increase the chances of getting a loan.
- Do not overuse your credit card
The amount of money you have available on your credit accounts is another component that affects your credit score. Make sure you don't use more than half of the credit limit you've been allocated.
- Do not apply for any loans
When you are done with settling your loan, do not apply for or inquire about a new loan in that period or in the next few months. That is because if you do that there are chances of loan denial.
- Try to get only right type of a loan
Your CIBIL score is also associated with the type of loan you take out. Explore various loan products available. Consider personal loans, secured loans, or credit builder loans, compare interest rates, terms, and eligibility criteria from different lenders and then apply for the loan.
- Convert settled to closed by paying the waived-off balance.
The most important part that needs all the consideration is that loan accounts which have been reported to the Credit Bureau and tagged as settled are updated as closed ONLY by paying off waived amounts which may include late payment charges and penal interest .
Conclusion
It is crucial to note that loan settlements keep impacting your credit score negatively forever. By way of getting a settled account as closed and actively managing other credit accounts responsibly and practicing good financial habits can gradually help rebuild your creditworthiness over time.
