People often confuse debt settlement with debt closure, whereas, in reality, the two greatly vary from each other. The major underlining difference between the two is that while debt closure is the normal course of closing the loan account upon full payment of the loan amount, in debt settlement, some portion of the outstanding loan amount is forgone by the debtor.
Debt settlement might appear an easy way to get out of the debt trap, but it has some serious implications on your financial health. Today, we will discuss the after-effects of a personal loan settlement that you must consider before moving forward with the settlement.
1. Impact on the CIBIL Score
One of the biggest downsides of a personal loan settlement is that it has an adverse effect on your CIBIL score. CIBIL score is a 3-digit numeric summary of your credit history, maintained by CIBIL, the most significant credit company licensed by RBI. It ranges from 300 to 900. The closer your score is to 900, the better your credit rating is and vice versa.
When a borrower opts for a personal loan settlement, the bank communicates this information to CIBIL, and it is recorded as a ‘settled’ and not a closed account. As a result of a loan settlement, the credit score of the borrower drops by 75-100 points, and this record is held for 7 years straight.
2. Impact on the Borrowing Capacity
A settled account is deemed bad credit behaviour by both the lender as well as other financial institutions. Whenever a loan turns bad, the relationship between the borrower and the lender is sabotaged greatly.
In addition to that, the CIBIL score of an individual and institution is easily accessible by all financial institutions. Therefore, if you wish to borrow funds in the distant future also, banks and other lending institutions can reject your request on the basis of your past record.
How Should Borrowers Deal with It?
In case of a loan default, there are different options that you can opt for besides loan settlement. However, since different options are suitable for different conditions, it is best to consult a debt relief company to get the best advice on available options. Here are a few different options that you can try:
1. Restructure Your Loan
Restructuring the loan refers to modifying the EMI amount and the tenure to make the situation a little easy for you. In case you find it difficult to pay the existing EMI amount, you can approach the lender and request an increase in the loan tenure.
A longer tenure helps to reduce the regular EMI amounts. Restructuring the loan will help you manage your EMIs better without default and will minimise the adverse effects on your other essential financial goals.
2. Offer a Collateral Security
Personal loans fall under the category of unsecured loans, i.e. it does not require any collateral backup. However, in case of a loan default, you can offer your collateral to your lender against the loan to avoid a settlement situation.
Collaterals act as a backup, considering that your lender might reduce the penalty on default. By avoiding the penalty, your interest rate and, consequently, your EMI amount reduce considerably.
3. Explore Deferring Payment Option
If the loan defaults are happening because of temporary financial hardship, you can opt for a deferring payment option. In this case, the lending institution allows you a brief pause of a few months before you can start with repayments again.
During this period, no interest is charged, but you have to pay the EMIs on the scheduled dates. The deferred payment option allows you some time to arrange the necessary funds without adversely affecting your CIBIL score.
Final Words
Loan defaults, if not handled with due care and diligence, can put you in a lot of trouble. Therefore, it is important to do meticulous research on the different options that you can try. It is best to get a debt-relief company involved as they have the required experience in this domain and can make the situation much easier and more suitable for you.
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