Sometimes, it might happen that you are unable to repay your loan due to unforeseen circumstances. For example, you may face a financial crisis, have an accident, or lose your job unexpectedly. If such situations arise when you are in the process of repaying a loan, there is an option called loan settlement.

When your lender agrees to a home loan, education loan, or personal loan settlement, they waive off the due amount on your loan and terminate your account with them. But this doesn’t mean settlement is a safe option and can free you from your repayment obligations. In fact, it can do more harm than good for your credit score!

In this article, we will explore what is a loan settlement and how it affects your credit score. We will also explore some options you can consider instead of settlement. 

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.

Is loan settlement the same as closing the loan?

No! Settling and closing a loan are two different things.

When you close a loan, you repay the due amount completely within your tenure. Making timely repayments reflects that you are a responsible borrower and increases your credit score.

But, when you settle a loan, you do not make a complete repayment. To the lender and credit bureaus, this indicates that you are not a responsible borrower, and it decreases your credit score.

Thus, loan closure and loan settlement have different impacts on your credit history. Whether it is a car loan settlement, home loan settlement, or education loan settlement, it adversely affects your credit score.

What is loan settlement’s impact on your credit score? 

If you have taken a housing loan and are repaying a high loan amount, the option of home loan settlement may look appealing at first. You may feel you are being let off the hook and feel a sense of relief. However, your home loan settlement comes at a dear cost. 

Whether you opt for a car loan, personal loan settlement, home loan, or home credit loan settlement, your lender always reports it to the credit bureaus. Credit bureaus record the home credit loan settlement in your credit history, and then your loan account with your lender is terminated.

Since settlement indicates that you have failed to repay your loan timely and the lender has incurred losses, your credit score reduces drastically. It may even fall by 75 to 100 points! So, if you do not have a high credit score, a home credit loan settlement can reduce it further and make it more difficult for you to apply for loans in the future. 

What are the alternatives to settlement?

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. 

The bottom line

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. 

Are you looking for affordable loan options? Tata Capital is here for you with easy loans at attractive interest rates and flexible EMI options. Our team of wealth advisors can help you with all our offerings.

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