Challenges such as business failure, job loss, medical emergency, among others, are common reasons that can cause a borrower to feel overwhelmed with their loans (debt). Correspondingly, a greater number of borrowers are seeking settlements when it is not possible to pay back the entire amount owed. It is important to understand how lenders view a settled account and discuss common scenarios associated with settlements.
Settled vs Closed Accounts
A loan account is considered ‘settled’ when a borrower, due to financial constraints, is unable to repay the full outstanding amount, and the lender agrees to accept a lower amount to close the account. This is different from a ‘closed’ account, where the borrower repays the entire amount as per the original loan agreement.
Lender's Perspective
While it is true that lenders typically view settled accounts with caution, below are instances where helping the lender understand your situation and your response towards it, can reduce the prejudice and mitigate traditional reactions towards settlements.
1. Genuine and Documented Hardship
The borrower must successfully demonstrate that his/her settlement was due to unforeseen and severe financial hardship, such as a major medical emergency, job loss, natural disaster, family crisis, and so on. As the lender is presented with adequate documentation, the borrower should highlight his/her intention to pay back and assist the lender in recognizing that the hardship was unavoidable. The borrower should emphasize recognition of his/her response to the uncontrollable (external) circumstances vs. a deliberate avoidance of the loan.
2. Proactive Communication and Cooperation with Lender
The borrower should ensure that he/she does not become unavailable and ignore communication from the lender, but rather proactively initiate contact in order to explain his/her situation and discuss with the lender to identify options. Lenders prefer that the borrower engage in transparent and honest communication, demonstrating responsibility and commitment to resolving the challenges rather than abandoning the obligation by becoming unresponsive.
3. Size of Settlement Relative to Overall Credit Profile
In case the settled amount was small, usually in the case of a personal loan and/or credit card, the lender will tend to focus more on the borrower’s overall credit profile. This includes the borrower’s history with larger loans (e.g. a home loan) and reviewing the size of the settled loan account relative to the overall credit profile. In case the borrower has demonstrated regular repayment on the other, more significant credit obligations, the lender typically understands that the earlier hardship was an isolated event rather than a systemic inability to manage debt.
4. Time Since Settlement
As time passes since a personal loan and/or credit card account was settled, it is important that since then, the borrower has shown signs of responsible borrowing by maintaining a good credit record. Lenders are more interested in recent credit behaviour. A recent period of regular repayment history after a settlement can demonstrate that the borrower has regained financial stability and learned from past experiences. In short, the older the settlement, the less weight it carries.
5. Subsequent Credit Behaviour
After the settlement, the lender carefully examines the borrower’s performance on subsequent loans. Specifically, how well the borrower has managed all other existing and new credit accounts – whether there are any defaults and/or late payments, and the amount of credit utilization (percentage of your available credit that you are using). A consistent track record of positive credit behaviour post-settlement can gradually rebuild trust, positioning the borrower as a reliable payer.
6. Unsecured Loan (Personal Loan, Credit Card) vs. Secured Loan
The lender examines whether the settled account was for an unsecured loan (like a personal loan and/or credit card), as opposed to a secured loan (like a home loan or auto loan where an asset is pledged). Defaulting on a secured loan is viewed as much severe because the borrower failed to make payments even when an asset was at stake. Settling an unsecured loan can be less damaging to the lender, especially if the borrower has a good history with secured credit.
Conclusion
First, it is important for borrowers to understand what is a settlement. Second, it is always recommended to get professional help to evaluate your options given your current situation, before proceeding with a settlement. Third, as discussed above, be aware of common scenarios regarding settlements. It is important for the borrower to engage in responsible credit behaviour and realize that settlements should not be considered as a routine practice but rather as a means of addressing genuine financial distress.