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Why Is Settling A Loan Sometimes A Bad Thing?

Here’s Why Settling A Loan Can Be A Bad Decision

Settling a loan, when recovery agents are constantly hounding for payment, looks like an amicable escape route. But soon the reality strikes—what appeared to be a let off turns out to be a deep trap.

A loan settlement destroys your credit-taking ability irreparably for no less than 7 years. Even after that, there is no guarantee that a lender will extend a helping hand and some credit when you really need it.

Read on to know what happens to your CIBIL credit report and score when you settle a loan, why settling an account makes you a pariah to lenders, and, most importantly, how to repair your credibility after you have defaulted.

Settling a loan unsettles your credit report

When you settle a loan, you pay only a part of the amount due to the lender. In other words, the lender incurs a loss on the transaction.

According to the rules, banks have to report all non-payment-of-loans-in-full cases to CIBIL. A relevant entry in case of settlement, “Settled” is written against the loan status, is then made in the CIBIL report. Inclusion of this entry in your report greatly affects your CIBIL score.

Why you cannot avail new credit till a “Settled” status is there

The “Settled” status is a black mark on your financial report. It tells lenders “this guy cannot pay a loan that he takes”. Not surprisingly then, seeing this remark, a lender instantly rejects your loan request.

A “Settled” remark stays for 7 years. The damage, however, often extend beyond that. Getting a loan after you’ve defaulted once can prove an uphill task, even after the remark has been removed. Your credit score takes a strong hit when you default. Until you boost your credit score, your loan application will always meet the same fate—rejection.

How to make yourself creditworthy after you’ve defaulted

Two things happen when you default: your credit score drops and a “Settled” remark enters your credit report. To improve your situations, you must do the following:

  • Pay the waived off amount as soon as possible

Let’s say your loan was for Rs 2,00,000. At the time you settled the loan, the amount due was Rs 1,50,000 (principal amount + interest accrued). You paid Rs 75,000 to settle the loan. That is, the bank waived off Rs 75,000.

As soon as your financial situation permits, you should pay back this waived off amount. The bank then will remove the “Settled” remark, and your report will read so much better because of that.

Note: Paying the waived off amount will erase the “Settled” remark from your report, but it will not instantly improve your credit history.

The Days Past Due (DPD) section will continue to highlight that you had defaulted in the past. This particular section shows how many months worth credit is due on a particular month.

A value of ‘0’ in the DPD section is positive as it means no dues; any other numeric value represents the number of days the payment has been due, and therefore carries a negative weight. For instance, if your DPD shows 30, it means the payment has been due for one month (30 days) and the entry will negatively affect your credit score.

Information for the last 36 months is listed in the DPD section. Each month a new entry is made while the last entry is discarded. So the period for which you defaulted will continue to appear on your report for no less than 3 years.

Here’s an example to understand this better:

You had a payment due in December 2014, but you didn’t pay it until April 2015. So the DPD value for January, February, and March will be 30, 60, and 90, respectively. The DPD value for April 2015 will be 0 because you cleared the balance this month. However, the DPD value confirming default payment will continue to be listed on the report until 2018.

DPD is one of the factors lenders look at before approving a loan, but it is not the most important one. Even with a negative DPD value you may be able to win a loan if you’ve got the “Settled” status removed and if you consistently follow the two prudent financial practices listed ahead.

  • Pay other loans on time

Your score will benefit from timely payments on other loans that you have taken. So ensure you don’t miss a payment.

  • Keep your credit utilization low

Two important messages you send to lenders when you keep your credit utilization low are you can manage your expense and are not dependent on credit.

A loan settlement is not a win-win situation that many think it is. To avoid all these troubles, pay off the amount in full, even if it means cutting corners somewhere.


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