When you take a loan or a credit card, you have to pay off all dues on time. Any default or missed payment can significantly damage your credit score, whereas timely repayments help maintain your high credit score. When you are unable to pay off your dues for more than 90 days, the bank marks the account as NPA. It will severely damage your credit score and make it almost impossible for you to avail credit.
However, the bank may offer you an option to pay off a lower amount and settle the account. It may sound like a relief in a dire financial condition, but it will have serious implications on your credit health in future. Let us understand why settling a credit account should be your last resort and why you should look for alternatives.
What Does the Settlement of a Credit Account Mean?
A default credit account is considered as settled when the borrower pays off a part of the loan outstanding after negotiating with the lender. Here, a smaller amount is recovered by the lender instead of the total outstanding against an NPA account where no amount was going to be recovered. The borrower, in financial distress, gets to end the loan at a lower value and the lender recovers some of its losses.
It may sound like a win-win situation for both, but there’s a catch for the borrower here. The account status in the credit report is flagged as “Settled”, which indicates partial repayment instead of being marked as “Closed” (which implies you paid off the dues completely).
While settling a credit account would resolve your immediate financial crisis, it would also mean that your creditworthiness in future would decline severely.
How Settlement Affects Your Credit Score
Settlement impacts your credit score negatively. As you weren’t able to repay your dues, it is viewed as a breach of your repayment obligation. Credit bureaus consider it a sign of financial distress and thus, they no more trust your repayment capability.
- A “settled” tag has potential to lower your credit score significantly and the severity depends on your existing score and overall credit health.
- It indicates to future lenders that you could default or be unreliable with repayments again.
This impacts your creditworthiness and hurt your chances of securing loans or credit cards in the future. Thus, you should settle your account only as a last resort and try to pay off your loan and close the account instead, even if it may take longer.
Read in Detail: Effects of Loan Settlement on your Credit Score
Debt Settlement Stays on Your Report for a Long Time
A settled account will remain in your credit report for as long as 7 years from the date of reporting. This is the most damaging aspect of credit settlement.
A missed payment in DPD (Days Past Due) remains in your credit report for 36 months and after that it is replaced by the newer timely repayments. But, in case of a settled account, it shall remain for long.
When a lender assesses your credit application, they look at the DPD data and past account statuses. Your DPD may recover in three years but your settled account status will haunt you longer. Even if you rebuild your credit score over time, a settled account in your report can lead to:
- Disqualification from pre-approved loan or credit card offers
- Stricter terms and higher rates on new loans
- Loan rejection from top lenders
Lenders See You as a High-Risk Borrower
A high-risk borrower is one whom lenders don’t trust completely for recovery of their investments. This is because they find an indisciplined credit behaviour, sometimes caused due to a default or settled credit account. Lenders considering you a high-risk borrower has potential to impact your:
- Loan eligibility
- Chances of availing a personal or business loan
- Higher interest rates and lower loan amounts for a secured loan
Difference between ‘Settlement’ and ‘Closure’
Lenders often look for two account statuses in your credit report – settled or closed. Let us understand the difference between the two terms:
| Term | Meaning | Impact on Credit Report |
| Closure | All dues paid in full | Positive or neutral impact |
| Settlement | Partial repayment after negotiating with the lender | Negative impact; stays for 7 years |
You should always aim for closure instead of settlement to preserve your credit health.
What Should You Do Instead?
If you’re facing genuine difficulty repaying your debt, consider these steps before going for a settlement:
- Negotiate for Restructuring your Repayment Schedule
You can request the lender to restructure your EMIs or provide a temporary relief (like moratorium). - Seek Waiver of Late Charges
On request, some lenders may waive off penalties, reduce interest rate or provide relief from late payment fee if you show intent to repay after a default. - Pay in Installments or Lump Sum
If you can, pay off the remaining amount in installments from time to time or pay off all dues and close the account.
Also Read: Credit+: Paisabazaar’s Credit Improvement Services to Help Build Credit Score
While settling a credit account might provide a short-term relief, it comes at the cost of damaged credit health in the long-term. It reduces your score, creates a negative mark on your credit report, and affects your ability to borrow in the future.
If your financial burden has reduced and you want to improve your credit score, you can contact your lender for updating the status of your loan account as closed from settled by paying whatever additional amount is required. If the lender agrees and updates the account status, you can see a rise in your credit score and an improved credit report.
