The loan settlement’s effect on credit score can be significant, especially if you are not able to repay your loan due to unforeseen events such as a financial crisis, an accident, or job loss.
Loan settlement occurs when your lender agrees to reduce the amount you owe, allowing you to pay a smaller sum and close the loan account. While this may seem like a quick solution, it can negatively impact your CIBIL score, with the “settled” status appearing on your credit report. This can make it even harder to secure future loans and affect your financial standing for years.
In this article, we will discuss what is loan settlement meaning, how it affects your personal loan settlement process, and explore alternatives to loan settlement that may be more beneficial.
What is loan settlement?
When the borrower cannot repay the loan, the lender can offer the option of a one-time loan settlement after assessing the borrower’s circumstances.
First, they assess the repayment that is due. After careful consideration, they write it off. Now, your loan is considered settled.
In some cases, they may give you a 6-month buffer period where you do not have to pay any EMI. After this period, you are required to pay a certain percentage of the due amount in one go and settle the loan.
The lender then reports a loss, and your repayment process is terminated. Depending upon their terms and conditions, lenders can allow car loan settlement, home credit loan settlement, education loan settlement, and even personal loan settlement.
How does loan settlement work?
Review your finances – Check if you are unable to keep up with payments ,and decide if settling the loan is the right choice.
Reach out to your lender – Contact your financial institution/lender to let them know you want to settle the loan.
Negotiate the settlement amount – Offer a lower amount you can pay and discuss the terms with your lender.
Get written confirmation – Make sure you receive a written agreement on the settlement terms.
Complete the payment – Pay the agreed amount to settle the loan.
Confirm loan settlement – Get confirmation from the lender that the loan is settled and the account is closed.
Benefits of loan settlement
If you’re struggling with unpaid loans, settling your loan can offer several benefits:
Relieves financial stress – Settling a loan can help reduce the pressure of unpaid debts, giving you some financial relief.
Avoids further legal action – By settling, you can prevent the lender from taking legal steps or further action against you.
Reduces total debt – You may end up paying less than the total loan amount, easing your financial burden.
Improves your financial position – Loan settlement can help you clear outstanding debt, improving your overall financial situation.
Simplifies the personal loan settlement process – The settlement process offers a way to resolve financial troubles without continued default.
Key considerations before opting for loan settlement
Before opting for a loan settlement, consider these points-
Check your finances to make sure settling the loan is the right option for you.
Understand how settling the loan will affect your credit score and your ability to borrow a loan in the future.
Negotiate carefully to get the best terms possible for the settlement.
Consider speaking to a financial expert/ advisor for advice before making a decision.
Make sure to get all the settlement terms in writing and keep proper documentation.
How does loan settlement impact your credit score?
Below are the ways in which loan settlement impacts your credit score:
Impact on future loans – Settling a loan can make it difficult to obtain new credit, as lenders may see it as a sign of financial instability, impacting your chances of approval.
Short-term vs long-term effects – The loan settlement impact on CIBIL score is negative in the short term, but it might be a better option than continued defaults or facing bankruptcy.
Credit report consequences – A loan settlement will be reflected on your credit report, and future lenders may use this information to assess your financial health.
Lower credit score – Settling a loan for less than owed can lower your credit score, which could affect your ability to borrow in the future.
What are the loan settlement alternatives?
Now that you know what happens after loan settlement, you should avoid it at all costs. Here are some tips:
Borrow only what you need: Firstly, whenever you take a loan, carefully assess your repayment capacity and borrow only what you need. By doing so, you can reduce your burden of repayment.
Ask your lender to revise your loan terms: If you are having issues repaying your EMIs as per the agreed-upon terms, do not rush to opt for settlement. Instead, talk to your lender about your situation and request them to revise your repayment terms. You can ask for a tenure extension or restructure your monthly instalments. By doing so, you will avoid harming your credit score and still be able to pay off your loan comfortably.
Use your investments and assets to repay the loan: Always have a safety net in place. For example, you can designate some investments like fixed deposits, stocks, bonds, gold, etc., that you can use if you need money. So, if you are ever faced with a situation where you need money to repay your loan, you can liquify your investments and arrange funds, avoiding loan default or settlement.
Difference between loan settlement and loan closure
The table below shows the differences between loan settlement and loan closure.
Aspect
Loan settlement
Loan closure
Repayment
Partial repayment of the loan amount.
Complete repayment of the loan amount.
Impact on credit score
Decreases credit score, as it shows non-complete repayment.
Decreases credit score, as it shows non-complete repayment.
Borrower’s responsibility
Indicates non-responsibility towards loan repayment.
Reflects responsible borrowing and timely payments.
Conclusion
You’ve now understood what loan settlement is. If you find it challenging to repay your loan, it is better not to opt for the settlement option. Settlement adversely affects your credit score and reduces your chances of availing of a loan in the future.
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Will I be eligible for future loans after settling a loan?
Settling a loan may lower your chances of securing future loans, as lenders often see it as a sign of financial distress, which could result in higher interest rates.
Can I negotiate better terms instead of settling a loan?
It’s possible to ask your lender to extend your loan term, restructure your EMIs, reduce the interest rate, or provide a temporary interest waiver, instead of opting for settlement.
Is there a way to avoid the negative impact of loan settlement?
To avoid settlement, you can use your savings, seek financial assistance, consider a secured loan, or get loan insurance to prevent defaults and minimize the need for settlement.
How long does a settled loan remain on my credit report?
A settled loan will appear on your credit report for seven years, impacting your credit score and affecting your ability to apply for credit during that period.
Should I choose settlement if I cannot repay my loan?
You should consider loan settlement after exploring other options like loan restructuring, extending repayment terms, or using personal savings to avoid negative impacts.
Is loan settlement good or bad?
Although loan settlement can reduce your debt and help you avoid bankruptcy, it can be one of the factors affecting your CIBIL score, making it difficult to obtain new credit or loans in the future.
08 May 2025
6 mins read
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