Financial crises can occur at any time in life, and no human being is prepared for a sudden financial crisis. As we are living in this fast growing economy, loans and credit cards have become easy and reliable options to manage these sudden financial crises. However, there are multiple personal loan options online to meet the borrower’s needs. Taking a loan might be easy and convenient, however repaying the loan amount is where the problem might arise. If you have faced a problem in repaying the loan amount, you might have come across the word “loan settlement”
After borrowing a loan, it is important to manage the entire repayment process responsibly. However, some uncertain circumstances in the financial journey might create a problem. In this case, borrowers usually explore the loan settlement process to come out of the situation. Hence, in this blog, we will understand what is loan settlement? how the personal loan settlement works in India, how you can submit the application for loan settlement, and how this process will affect your credit score and future borrowing ability.
What Is Loan Settlement?
The settlement of a loan means an agreement between both the borrower and lender by which the amount to be reduced is accepted as full and final payment by the lender.
However, it usually occurs when the borrower is unable to pay the entire loan amount and has already defaulted on the loan.
In simple words:
- You borrowed money.
- You can not repay the total outstanding amount.
- The lender agrees to accept a lower lump amount.
- The remaining balance is cancelled.
- The loan is marked as “settled” (not “closed”) on your credit record.
It is better to keep in mind that the concept of settling the loan is different from closure of the loan. Moreover, closure means an agreement where you have paid everything you agreed to pay, whereas settlement implies an agreement where you pay less than what you owed.
Understand The Loan Settlement Process:
Before opting for the loan settlement option, it is important to first understand how the process for a loan settlement works.
Here is a step to step guide on how this works:
- Assess your financial condition
If you are unable to pay back the loan amount, initially understand the amount you owe and how much you are able to pay back as a lump sum amount.
- Communicate to the lender
Always remember to contact and communicate your condition to the lender. Hence, reach out to your bank or NBFC and try to understand the after process, amount to be paid etc.
- Application for loan settlement
You need to write a written letter for application for loan settlement explaining the reason behind the loan settlement along with some documents as proof like job loss letter, medical bills etc. This will help the lender to understand and believe in your condition.
- Negotiation
After a clear consideration of the borrower’s financial situation, the lender will then decide and offer a settlement amount, usually the amount varies between 40% – 80% of the outstanding balance amount.
- Settlement amount payment
After all the formalities are done, both the lender and the borrower decide and agree on a settlement amount which is later paid by the borrower in lump sum amount.
- Get settlement letter
Once the loan settlement process is completed, always remember to collect the “Full and Final Settlement” letter. This will remain as proof that you have completed the said amount by your lender and avoid future disputes.
Loan Settlement Example:
To make the it easier for you to understand, here is a an example of the process of loan settlement:
| Category | Amount |
| Original loan amount | 3,00,000 |
| Outstanding amount (after default) | 2,20,000 |
| Settlement offer (60%) | 1,32,000 |
| Amount waived off | 88,000 |
| Credit report status | Settled |
Here, the borrower pays ₹1,32,000 instead of ₹2,20,000. The lender is writing off the amount of ₹88,000. The account stands as “settled” in the credit report.
Effects Of Loan Settlement On Credit Score:
It is necessary to maintain a good credit score. And one of the important factors to get impacted after a loan settlement is your credit score. Let’s understand the impacts on your credit score.
- Drop in credit score
A loan settlement is done when the borrower is unable to repay the loan amount due to some financial conditions, as the loan is marked “settled” this affects the credit score and it will drop significantly.
- Negative marking on credit report
When the loan repayment is completed and the entire amount is paid by the borrower, it is mentioned as “closed” on the credit report. However, due to loan settlement, on the credit report, it will be shown as “settled” instead of “closed” This will be viewed as negative by the lenders for further loan applications.
- Difficulty in future loan approvals
As the credit report will show the loan settlement on your profile, this creates difficulty in future loan approvals as lenders or banks may find it difficult to trust the borrower again because of the previous loan settlement.
- Higher Interest Rates
Even if it is approved, the borrower will face higher interest rates due to perceived risk. Maintaining a clean and clear credit report allows the lenders to provide various offers and low interest rate charges.
These are long term impacts and can be on your credit report for several years.
Key Things To Consider Before Applying For A Personal Loan Settlement:
Keep these following key points in your mind before commencing the loan settlement process:
1. Long-term Financial Objectives
If you plan on applying for a home loan or a car loan in the future, then settlement may create obstacles.
2. Negotiation Strategy
Do not take the first offer right away; you may negotiate a better sum in settlement.
3. Written confirmation is required.
Never trust a verbal agreement. Always get it in writing and have it signed by the other party involved.
4. Tax Implications
Sometimes, this amount of waiver is treated as income under tax laws.
5. Find better financial planning tools.
If this financial stress is temporary, consider budgeting calculation tools and EMI calculators for reorganizing the payments rather than going for a settlement immediately.
For example, platforms such as Olyv enable financial planning tools and calculators through which the borrower can better understand their EMIs and make further financial decisions after such planning. Of course, settlement can be achieved, and at other times, it may be prevented through smarter planning.
Can You Improve Your Credit Score After Settlement?
Yes, it takes time and discipline.
To Rebuild Your Credit:
- Payment of all due EMIs.
- Avoiding multiple loan applications.
- Use credit cards wisely.
- Keep credit utilization below 30%.
- Check your credit report regularly.
Responsible behavior over time can improve your credit score.
Final Thoughts On Loan Settlement Process:
It is very important to understand what loan settlement is before reaching any decision. The loan settlement procedure may reduce the immediate burden of your finance; however, this negatively affects your credit score and future eligibility for a loan. An application for loan settlement should only be submitted after exploring all other options for repayment.
Always think long term. Your credit profile will play a huge role in any future financial opportunities. Borrow wisely, plan carefully, and use financial tools to stay ahead of repayment challenges. Settlement can solve a short-term crisis, but responsible financial management ensures long-term stability.
