Financial emergencies can occur anytime, and they can damage your regular finances. It can make repaying dues a tough ask and may lead to late payments, and sometimes, to default. Eventually, your lender may ask you to settle the loan account at a lower amount. Should you settle the account or not? How does a settlement impact your credit score? Let us find out below.
What is a Loan Settlement?
When a borrower is unable to pay dues on time and the account has defaulted, the bank declares the account as NPA. NPAs are non-performing assets, and lenders do not expect recovery of the remaining balance from NPA accounts. Thus, they offer the borrower the opportunity to settle the account at an amount lower than the actual remaining amount. Once the borrower accepts the offer and pays this amount, the lender closes this account and marks it as “Settled”.
The account status and payment information are also passed on to the credit bureaus. Credit bureaus use this information to calculate the latest credit score of the borrower.
How Does Loan Settlement Impact Credit Score?
Even though the loan settlement may seem lucrative for a borrower at first, it can have detrimental effects on the credit score. Lenders have to bear a substantial amount of financial loss through interest income when they settle a credit account. Every waived-off amount is mentioned as a loss in the record books of the lender.
Loan settlement signifies that the borrower was unable to repay the loan in full and thus was responsible for the lender’s loss. Hence, the borrower no longer remains a trusted applicant, and thus, his creditworthiness diminishes. This is shown in the credit report as well, where the credit score of the borrower takes a huge dip.
This leads to a difficult scenario for lenders who want to approve the borrower’s credit application in future.
Can a Borrower Get a Loan after Settlement?
Any settlement information can remain in the credit report for 3 to 7 years. All payment information remains in the credit report for thirty-six months in the form of DPD, and the account status remains in the report for at least 7 years.
Suggested Read: How Long Does Negative Information Stay in CIBIL
Any default or settlement information in the credit report raises a red flag for a lender who checks your detailed credit report before approving your latest credit application.
It completely depends on the lender to approve your credit application after witnessing a settlement in your credit report. While most lenders offering better loan terms may refrain from approving your credit application, many lenders look at the period since settlement and your credit behaviour after that.
In case the credit behaviour does not improve over time and the borrower keeps on missing deadlines time and again, no lender would approve any credit application.
However, if the borrower mends the credit behaviour, starts rebuilding the credit score and maintains a strong profile after settlement, lenders may still consider their application.
Also Read: 5 Most Important Things that Lenders Check in Your Credit Report
How to Get New Credit after a Settlement?
A borrower may still be able to secure credit after settlement, but it can be a tough challenge. In case you want to secure a new credit after settlement, you should follow these points diligently:
Build a Habit of Timely Repayments
Start repaying all your dues on time. Never miss any payments and avoid paying only the minimum amount due against your credit card bills. A “000” DPD against your credit accounts from now onwards would help you rebuild your credit score and showcase to the lender that you have overcome all financial challenges and have stabilised your finances. This can be very beneficial in case you intend to apply for credit, even at a higher interest rate.
Keep your Credit Utilisation Low
Credit utilisation may play a limited role at the time of credit approval if you have a high credit score, but when your score is low, it becomes very important for lenders.
Having a high credit utilisation shows your overdependence on credit. A high utilisation also increases your chances of default in case of a financial crisis. Keeping credit utilisation below 30%, as recommended by most experts, can help you grow your score slowly.
Avoid Loan Enquiries
When you have settled your account recently, your credit score takes a significant dip. Your credit applications may not get approved at all. In case you apply for credit in this scenario, there are very high chances of rejection, and it may further reduce your credit score.
Avoid loan enquiries during this period and focus only on rebuilding your credit profile. In case you settled your credit account way back and have been following a decent credit behaviour since then, you may witness your credit score improving gradually.
When your credit score reaches the good/very good mark (760+), it shows that you have rebuilt your credit profile and have improved your creditworthiness. Even though many top lenders may still refrain from approving your credit application, many lenders would finally consider your application and approve it.
Apply for Secured Credit
When your credit score has fallen due to credit settlement and there are no chances of new credit approval, you can consider rebuilding your credit score. This can be done by availing secured credit such as a loan against assets, secured credit cards, gold loan, etc. Since these credit products are backed by collateral, a lender may not consider your credit score for approval.
Using these products smartly and repaying all dues on time will not only help you fulfil your financial obligations at present but also help rebuild your credit score in the long run.
Also Read: Why should you not Settle a Credit Account
Loan settlement may look lucrative, but it should be your last resort. It damages your credit score and stays in your credit report for a long period, making it difficult to get credit approved in future. It reduces your creditworthiness, and financial institutions may still not trust you for big-ticket loans even if you mend your credit behaviour.
You can get in touch with your bank and request that it update the status to “closed” instead of “settled” by paying whatever remaining amount is required, if possible. If the lender agrees, your credit score may improve, and you may be able to get approval for new credit in future.
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