You know well about the debt management strategies and healthy practices to maintain creditworthiness. But what happens when you face an unexpected, genuine financial difficulty with unpaid debts? This is the loan settlement process in India.

 

RBI had introduced the loan settlement, also known as compromise settlement or one-time settlement, in India, with some guidelines and rules for both the lender and borrower. This is the process when the lender agrees to a percentage of loan repayment in case of the borrower's genuine financial hardship and supporting evidence.

Loan settlement is not a knee-jerk reaction. How loan settlement affects CIBIL score is a hot topic, and a borrower must weigh their options carefully before deciding on a negotiation. This is because, on the one hand, it reduces your financial stress, and on the other hand, it has a long-term effect on your credit future and credit report.

It's best practice to make a full repayment rather than a loan settlement. You can also repay the remaining amount after the loan settlement process. You don't want the classic 7-year settled tag on your credit report.

So how does loan settlement affect CIBIL score?

Loan settlement affects CIBIL score: Impacts

How does a loan settlement affect your CIBIL Score and harm your credit profile?

There are always missed payments and delinquencies before the final settlement. If you are still making payments, you will not be eligible for a settlement. Therefore, the delinquencies keep piling up. The entire process before a settlement already has a considerable impact on your credit score.

This is further highlighted by a 100-point drop after settlement, and the settled tag will continue to have a negative impact on your credit score. So a practical rebuilding method may seem like a far-fetched option, and recovering credit will become much more difficult. The settlement reflects on your credit report for 7 years.

Now that you know the consequences and how loan settlement affects CIBIL score, it is important to weigh your odds carefully. Carefully evaluate the pros and cons of a loan settlement in India.

Pros

Remove financial stress and debt.

The debt continues growing, with more and more interest and delinquencies. The unpaid EMIs keep piling up over months, and the several negative terms on your credit report can be overwhelming.

Reduced liability

It saves you considerable money on the overall stressful balance.

Stops harassment or possible bankruptcy

It removes the possibility of pressure for repayments, collective calls, and possibly ending up bankrupt.

Faster Resolution

It ends the cycle of debt in a faster agreement, which could have impacted you throughout your life.

Cons

Your score drops

Your credit score drops up to 100 points after settlement. For example, if you maintain a good 730 CIBIL score, it will drop to 630.

Loan Rejection

Future credit or borrowing applications are more likely to be rejected. Even if approved, it will only receive unfavorable terms.

Settled tag

The settled tag stays on your credit report for 7 years. Loan settlement affects CIBIL score in the long term and creates a lasting negative impression.

Loan settlement affects CIBIL score: How does it work?

Loan settlement is not just a debt management or coping mechanism; it is also a strategy that bears considerable risk on your credit health and credit score. Lenders prefer a partial repayment rather than suffering a complete loss from the borrower. However, the RBI has mandated the borrower to present real evidence of genuine financial difficulty. If you can still make EMI payments every month, you can not be eligible for a loan settlement in India.

Loan settlement might look like a formal, legal resolution, but it continues bearing negative impressions on creditors and lenders. For them, it is less like a resolution and more like a financial loss written off or forgiven. It is a failure of compliance towards a promise of full repayment from the borrower’s end. What’s more, the lender is not guaranteed to accept your negotiation.

So how can you make a final decision? If it is still risky to negotiate in financial difficulties, who is supposed to propose a loan settlement? The thing is, the RBI already has rather strict guidelines to protect this process.

Only a person who communicates genuine financial hardships, months of unpaid debt, and documented proof of the condition will be eligible for a loan. You have to explain your circumstances to the lender and how much you can afford to repay. However, the final decision still rests with the lender– he might still reject you even if you meet the basic eligibility criteria. He has the final say on evaluating the true level of your financial difficulty, independent of any rule that protects a borrower’s ‘say on settlement’.

Banks may also offer a settlement process after the borrower is classified as a Non-Performing Asset.

When you explain your situation to the bank authority, you have to make sure you do your best to present your case as genuine. You should do your best to make possible offers to help the lender conclude. However, this conversation is not subject to any arbitrary decisions, of course. It is a legal and official process for which the RBI requires a board-approved policy. 

What are my alternatives?

Before making a final decision, it is critical to stay vigilant and informed and ask yourself some questions:

“What are some other negotiations that I can make with the lender?”

●     Debt Consolidation

●     Interest Reduction

●     Tenure Extension

●     EMI moratorium

It is very likely that if you explain well and present some options that you can work on, the bank authorities will understand your situation and efforts. Only go for a debt settlement if any of these offers don't work for you.

Credit Card Settlement process in India

Just like there is a loan settlement, there is also a credit card settlement process in India. It is an agreement between a credit card provider and a borrower to agree to a lower repayment and forgive the overdue account after missed payment of 90 days.

The difference between a loan settlement and credit card settlement is that credit card interest compounds much faster than a loan. This is because of daily compounding on revolving credit and higher interest rates. Even the repayment structure differs largely between the two credit types.

So the question arises, ‘does a credit card settlement affect credit score in the same  way as a loan settlement affects CIBIL score?’ The answer is yes.

How does Credit Card Settlement Impact Credit Score?

The ‘Settled’ Tag

Just like loan settlement affects CIBIL score, the ‘settled’ tag is applicable to a credit card settlement as well. The ‘settled’ tag stays in your credit report for 7 years and indicates financial stress, creating a lasting negative impression on lenders.

Credit Score Drop

Your credit score drops by 75 to 100 points after a credit card settlement. Believe it or not, this drop becomes more conspicuous if you had a good credit score before the settlement.

How lenders view this

Everyone who has permission to or access to your credit report can see this ‘settled’ tag. This creates a negative impression on the lenders and significantly reduces your chances of securing a loan in the future.

Conclusion

The settlement of a loan or credit card in India is quite a mixed blessing. While it comes with the immediate relief of getting rid of your EMIs and the threat of going into bankruptcy, it comes with the long-lasting negative impact of leaving marks on your credit history. Loan settlement affects CIBIL score by dropping 75 to 100 points.

It is because of these reasons that loan settlement should only be taken up as a last resort after having tried other options like debt consolidation, interest rate reduction, extended period of repayment, or a moratorium on EMIs. Although the RBI has provided some guidelines according to which the bank has to grant loan settlement in case of genuine hardships and proper documentation for the same, it is finally left to the discretion of the bank whether it wants to do so or not. In simple terms, loan settlement is nothing but a compromise.

FAQs

Can I use the credit card after settlement?

The credit card is permanently closed after the credit card settlement. Therefore, you can't use that credit card.

How to rebuild credit score after loan settlement affects CIBIL score?

Change the status from ‘settled’ to ‘closed’:

●     Pay the pending balance at the time of settlement by contacting the lender. 

●     Getting the NOC (No Objection Certificate) is mandatory.

●     Raise a dispute at CIBIL to change your status from ‘settled’ to ‘closed’.

Does the ‘settled’ tag for loan settlement affect CIBIL score for 7 years?

Yes, the tag stays for 7 years in your credit report. However, its impact reduces over time.

What are the disadvantages of credit card settlement?

●     Creditors can refuse your proposal at their convenience. 

●     The amount waived can also be marked as taxable income, if not always.

●     The 90-day gap, which makes you eligible for loan settlement, affects CIBIL score by piling up delinquencies.

●     Your credit score drops significantly and recurs the negative impact for years when a loan settlement affects CIBIL Score.

What are the alternatives to loan settlement?

The options that you can consider for help before finally resorting to a loan settlement:

●     Debt Consolidation

●     Interest Reduction

●     Tenure Extension

●     EMI moratorium

For credit card settlement:

●     Debt Restructuring Loan

●     Debt Consolidation

●     Credit card EMI conversion

●     Balance Transfer