Loan settlement is frequently confused with loan closure. However, these are two distinct terms with distinct effects on the credit score. If you make your monthly payments on time and in full throughout the term of your loan, the loan account will be cancelled automatically once the loan is paid off. The same information is subsequently provided to credit rating agencies, which improves your credit score.
A loan settlement, on the other hand, occurs when the borrower fails to complete repayments due to unavoidable circumstances. When an unnatural loan account closure is reported to credit bureaus, it has a negative influence on the borrower’s credit score, affecting the borrower’s ability to acquire approvals for future loans.
The same information will be provided to credit reporting agencies, and because you have successfully paid off the loan, it may have a positive impact on your score. Continue reading to learn how the preceding scenario differs from loan settlement and how it affects your credit score.
Loan settlement
The lender verifies and certifies that the defaults are the result of a valid reason beyond the borrower’s control.
Once the information has been verified, the lender will provide a one-time settlement choice. The lender offers to pay off the interest and penalties on the loan in a single payment (less than the outstanding loan amount). The settlement amount is determined after evaluating the borrower’s repayment capabilities as well as the severity of the circumstance.
Once the debtor has made the loan settlement payment, the lender writes off the loan, closes the loan account, and reports it to the credit bureaus as “settled.”
Borrowers view loan write-offs as an opportunity to pay less for the loan account’s closure. Most borrowers, however, are unaware of the inner calculations and ramifications of such a settlement. Borrowers may be bothered by a single mistake for up to seven years, or as long as credit rating organisations keep the information in their database. Do not be persuaded by lenders’ one-time loan settlement choice unless and until you do not have a bother option.
Impact on credit score
If you accept the one-time loan settlement offer and pay the settlement amount, the lender cancels the loan account and reports it to the credit agencies as “settled.” The settled account is not a standard loan account closing. As a result, it is regarded as a negative incident that reflects poorly on your credit behaviour.
A settled account simply deducts 75 to 100 points from your credit score, making future loan approvals tough for the next seven years.
Alternatives
Although a loan settlement may appear to be an appealing alternative (lower repayment amount), accepting the offer may not be a sensible financial decision (negative impact on the credit score). Accepting a loan settlement offer should be your final resort.
If you are having difficulty making monthly payments, look into alternative financing options.
Consider the following alternatives before accepting a loan settlement offer:
- Make use of your money and assets.
- Borrow money from friends and family.
- Negotiate with your lender to modify your loan, lower your interest rate, or prolong the payback period.
- Take out a low-interest personal loan to pay off the entire balance.
