Per the Reserve Bank of India’s latest Financial Stability Report, nearly 50% of borrowers availing credit card and personal loans have another live loan outstanding, e.g. housing and/or vehicle loan. So do not worry, you are not alone in feeling overwhelmed with your loans (debt)! Challenges such as business failure, job loss, medical emergency, among others, are common reasons that can lead a person to fall into a debt trap. As a result for many borrowers, it is not possible to pay back the entire amount owed.
What is Debt Settlement
Debt Settlement allows borrowers – that are struggling to make payments on their loans due to financial constraints – to settle by paying a lower amount than what is owed on their credit cards and/or personal loans. For example, if a borrower has an outstanding credit card balance of ₹500,000, the lender might agree to settle the debt for ₹290,000. Upon this reduced payment, the lender closes the loan account, releasing the borrower from any further repayment obligations.
Debt Settlement is considered by borrowers facing genuine and verifiable financial hardship, who can demonstrate an inability to repay. Lenders are willing to opt for a settlement to recover a portion of their funds and avoid the potentially lengthy and uncertain process of legal recovery.
Debt Settlement Process
1. Establishing Financial Difficulty
Prior to commencing Debt Settlement, the borrower must assess their financial situation to recognise their inability to meet the scheduled payments on their personal loans and credit card dues. Below are common instances when the borrower must realize the urgency of addressing this serious issue:
- Consistently missing payment deadlines
- Struggling to meet minimum payment deadlines
- In case of making minimum payments, seeing outstanding balance increase due to high interest rate
- Feeling overwhelmed due to one large / multiple loan accounts
- Beginning to receive phone calls and visits from lenders
- Beginning to receive legal notices from lenders
2. Communication with Lender
The next step is to initiate communication with the lender. Contacting the lender early demonstrates a willingness to find a solution rather than continuing to default on your loan. It is important to be honest and transparent about the reasons for your inability to repay and understand the options available. In certain cases, the lender can ask for evidence to support your claims regarding inability to repay.
3. Negotiation
This is a critical part of the Debt Settlement process, and ideally the borrower should get professional assistance. There are various companies that have dedicated Counsellors to guide borrowers through the process. Key advantages of utilizing professionals include:
- Handholding and psychological support
- Assistance in estimating the borrower’s present financial capacity
- Fluency in assessing factors that lenders consider during negotiation
- Negotiating and agreeing on an amount that matches the borrower’s affordability
4. Reaching a Settlement Agreement
Once the borrower and lender agree upon a settlement amount and timeframe, the lender should issue formal communication to the borrower, with requisite details. The communication should clearly state that the borrower will have no further liability once the settlement amount is paid.
Again, getting professional assistance will ensure that all terms and conditions mentioned to the borrower are stated in the communication received and reviewed adequately. In case of any doubts, the Counsellor can provide guidance.
5. Payment and Loan Closure
The borrower should keep in mind that in case of any delay in paying the agreed upon amount within the stated time period, the lender may revoke the offer. Upon payment and loan account closure, formal communication received from the lender should include essential information on the borrower’s account among other required details.
Implications
Debt Settlement is a significant financial decision for the borrower. As with anything else, various aspects should be weighed before proceeding:
- Reduced financial burden: Debt Settlement allows for the loan account to be settled for less than what is originally owed. This can result in savings for the borrower, putting the borrower on a faster track to financial recovery.
- Faster Resolution: Debt Settlement allows for a quicker way to resolve the borrower’s debt issue as compared to struggling for months and potentially years of making payments. This clear end date terminating the loan account offers freedom from trauma and certainty in future financial planning.
- Impact on Credit Score: While Debt Settlement will typically have a negative impact (by lowering the borrower’s credit score) immediately, it is often viewed as a step forward in improving the credit score in the medium term. For instance, a "Settled" status, while not ideal, demonstrates that the borrower took action to resolve the debt, unlike a loan that remains in default for an extended period. Professional assistance can help in understanding mechanisms to fast-track improvement in the borrower’s credit score.