Loan settlement is a big financial decision. It happens when a borrowers miss paying loan dues. This one-time payment is made to the lender when the borrower demonstrates his/her inability to repay the loan due to severe circumstances like illness, job loss, or some other financial trouble. After the loan settlement, the loan account is updated as ‘settled’ on the credit report. When the borrower chooses to settle a loan by paying a part of the outstanding debt, it has implications for the credit history and credit score. Loan settlement is reflected on your credit report, and your credit score decreases.
A loan defaulter may like to exercise this option, but it is important to note that doing so can negatively affect your credit score, and lenders might be discouraged from offering you a loan in the future. Though a loan settlement can bring down your score, you must know that your credit score is based on many other factors, too. Gradually, the impact of a loan settlement will lessen, and you can improve your credit score by maintaining a good payment history on other accounts.
Understanding the degree of loan settlement impact is vital for individuals to assess their financial obligations well and maintain their credit profile. In this blog, we will know what loan settlement is and how it affects the credit score.
What is loan settlement and how does it work?
Loan settlement or credit settlement is an agreement between the lender and creditor in which the debtor pays a part of the total amount of the loan, which is lesser than the loan outstanding.
A loan settlement is advisable when there is no other loan repayment option. The borrower must approach the lender expressing their inability to repay the loan and request a settlement. The lender assesses the borrower’s financial status by studying the details like employment, income, assets, liabilities, etc. Then, both the lender and the borrower mutually decide the settlement amount based on the borrower’s repayment capacity. A formal agreement containing all the settlement terms is signed, and the borrower makes the agreed amount of payment. Duefactory, the credit repair and loan settlement agency, can drive the process on your behalf.
The Impact of Loan Settlement on Credit Score
Here is what happens when you go for a loan settlement:
- When the lender writes off the loan, they inform the credit bureaus immediately. The bureau ends the loan tenure and updates the credit account as ‘Settled’.
- When a loan is termed ‘settled’, the borrower’s credit score drops considerably, and the creditors view the same as a negative credit behavior.
- The credit rating agencies hold this information for several years. If the borrower applies for another loan during this time, the lenders may not approve the loan considering the poor repayment capability of the borrower. So, the borrower may find it challenging to apply for fresh credit and approve their application for the loan.
- It is essential to note that the impact of a credit card or a personal loan settlement on your credit score depends on the loan amount outstanding or how many payments are unpaid, how much time you were delinquent, etc. The greater the time, the higher the negative impact.
- Also, if you have a strong credit history and a good credit score, loan settlement may have a lesser impact than those with a history of missed payments or poor scores.
How to Build a Credit Score After Loan Settlement?
The good part is you can rebuild your credit score after a loan settlement. The steps below can help you regain financial credibility and have better future credit opportunities.
1. Develop Good Credit Practices
This is the most crucial thing you can do to improve your credit score significantly. Start paying your credit card bills and EMIs on time and develop a positive history. This will help erase your negative history and improve your report.
2. Pay Dues Timely
Your payback history is another key indicator of your credit health. Making timely payments without crossing the due date is a good credit habit. This will gradually build robust credit health and restore your credit score.
3. Pay Outstanding Dues
Do you have any other loans or pending credit card payments? Paying off loans and other dues will save interest and lower the overall outstanding sum of money.
4. Apply for a Credit Card
Apply for a credit card and ensure to make timely payments. Doing so can show yourself as a responsible borrower and improve your credit score.
5. Maintain Low Credit Utilization
The amount of money on your credit account also affects your credit score. Don’t increase your credit utilization by more than 30%.
6. Do Not Apply for new Loans.
If you recently settled your loan, do not apply for a new one for the next few months. There is a chance of loan denial, and the lender’s ‘hard inquiry’ may further decline your credit score.
7. Professional Advice
Connect with settlement loan companies like DueFactory to skyrocket your credit score. We help you with best practices that considerably improve your credit score and develop your creditworthiness.
Wrapping Up
While loan settlement lowers the credit score, it is also one of the ideal ways to manage debt if you are struggling financially. Know the benefits and drawbacks wisely before deciding the right option. Talk to DueFactory, the credit counselor, for personalized loan settlement guidance.
Also, loan settlements adversely impact your credit score, but there are effective ways to rebuild it. Manage other credit accounts responsibly and practice healthy financial habits. This will rebuild your creditworthiness over time, the lenders will start viewing you as a responsible borrower, and begin approving your loan requests.
Disclaimer: This article provides a general guide to the subject matter. You should seek specialist advice about your specific circumstances.
FAQs
1. Should I monitor my credit score frequently?
Ans. Yes, you must get your credit report and track your credit score regularly. This will help you see the results of your credit-building efforts. DueFactory can provide you a free credit report.
2. What is the impact of loan settlement on credit score?
Ans. Loan settlement can lower your credit score. The severity of the impact depends on factors such as your credit history before loan settlement, the number of unpaid payments, the time of delinquency, etc.
3. Does bankruptcy decrease the chances of getting a new loan?
Ans. Once an individual files for bankruptcy and goes for loan settlement, the lenders consider the borrower a high risk. It is challenging to get new credit lines or loans until you re-build your score. Also, the loan will demand a higher rate of interest and offer less favorable terms.
4. How does loan settlement work?
Ans. If you cannot repay your debt completely, you can approach the lender for the same. You may get a six-month repayment period, and then you will have to pay an amount lower than the actual outstanding amount as a one-time payment (OTS).
5. Can I remove the loan settlement from the credit report?
Ans. Yes. You can contact your lender and pay the unpaid debt on your loan. The lender will provide you with a “No Objection Certificate”, which you can send to credit bureaus. After 30 to 45 days, the status of ‘settled’ will be revised to ‘closed’.
6. Can you improve your credit score after loan settlement?
Ans. Yes. To improve your credit score after loan settlement, develop healthy credit practices, pay all your dues, make timely payments, keep your credit utilization ratio lower, apply for another credit card and show responsible credit behavior, avoid applying for a new loan, etc.