Effects of Loan Settlement on Your Credit Score

On taking a loan, most of us try to repay it in time so as to not let it impact our Credit Score negatively. However, sometimes making timely payments may not be possible due to one reason or the other. This can negatively impact your credit score while making it difficult to get your loans approved in future.

But if you approach your lender, they might offer you to get into a settlement where your bank agrees to accept part payment of the loan. Also, you might be given extra time to repay the mitigated loan amount. Though it may look a lucrative option to you but such a settlement can unsettle your credit history.

Also Know: How to check your credit history for free?

Side Effects of Loan/Debt Settlement on Credit Score 

A one-time settlement of a loan between the lender and the borrower is called OTS in banking parlance. If you enter into an OTS, it conveys that you (the borrower) accept that you are incapable of paying the loan amount in full. This information is shared with credit bureaus by the bank and the loan account is shown as “settled” instead of “closed” in your credit report which can lower your credit score.

A closed account means that the loan has been paid in full and you have done well in repaying the loan whereas “settled” means that you were incapable of repaying the loan in time and thus you can be a risky borrower in future as well. Thus, it will lower your credit score.

Low credit score – Low creditworthiness – Fewer chances of getting a loan in the future

This settlement in your credit report along with your lowered credit score will pull the lenders away from you. They will be reluctant to give you a loan in future. If you approach a bank for a loan, it is highly likely that your loan application will get rejected.

When should you consider getting into a loan settlement?

You should get into a loan settlement agreement only when you have exhausted all the other options to pay off your loan. This includes withdrawing funds from your savings and/or investments like a fixed deposit.

If you find loan settlement to be the last option, after consulting with a financial advisor, go ahead with getting the loan settled.

Please note that this option should only be considered when you are totally unable to repay the loan amount in full. Your priority should be to pay off your debt in full and within the stipulated time.

Important Aspects of a Loan/Debt Settlement

Any loan that is due by more than 90 days is classified as a non-performing asset by the bank and 180-270 days after the payment date, the bank writes off the loan.

However, the settlement can happen before or after the write-off. If the settlement has happened before the write-off, the credit report will be updated as “settled”. But if the settlement happens after the write-off, the credit report will be updated as “post-write-off settled”.

Under both conditions, it will impact your credit score and will be considered a negative mark by the banks and other financial institutions. They will be reluctant in giving you a loan in the future. If given, you will be charged with a higher rate of interest.