When it comes to calculating your CIBIL score, many of us know that the score is determined by five important factors – debt repayments, credit vintage, credit mix, credit utilization, and new credit. These factors impact your credit score and you try to take care of them to maintain your score. While it is a good practice, do you know that there is one thing more which affects your score?
Loan settlement is one such thing that has a major impact on your credit score. Do you know how and why? Let’s find out –
What is a loan settlement?
Loan settlement is the last step taken by the lender to reclaim a part of the loan when you are in a financial crisis. If the loan repayment defaults consistently, the lender enquires the reason for default. If it is found that you have hit a rough financial patch that would continue for some time, the lender might offer you the option of loan settlement.
Under this option, you and the lender decide on a lump sum amount which should be paid to settle the loan once and for all. The amount is lower than the remaining balance of the loan and the difference is treated by the lender as a loss. Once the loan account is settled, you are free from the debt and the loan is considered to be paid off.
How it affects your credit score?
Loan settlement is considered to be a curse on your credit score. Though you feel that you are free from debt, settling off your loan actually traps you in a bad score and remark for years. When you opt for a loan settlement, the lender informs the credit bureau of the decision taken. The bureau adds a remark against the loan which is settled. The remark is ‘settled’ and not ‘closed’. ‘Settled’ means that the loan was terminated owing to financial difficulties and is an unfavorable remark for the borrower.
This remark stays in the credit report for 7 years. Within this period, if you seek for another loan, the lender would see the remark. They will reject your loan application straight away. No negotiation would be entertained if you have a ‘settled’ remark in your credit report. Moreover, besides the long-term effect of settling the loan, there is also an immediate effect. As soon as the loan is reported to be settled, the credit score falls down 50 to 100 points.
So, settling your loan is not a good choice both for your short-term credit score. It is also not good for your long-term credit report. Rather than freeing you from the credit, settlement binds you to loan rejections for seven continuous years after the loan is settled. So, don’t opt for settling the loan. Don’t do even if it looks like a good choice at the time and frees you from your loan.
If you are in a financial crisis, negotiate with the lender to extend the repayment tenure. So that you can pay off the loan. You can also use your savings and assets to pay for the loan partly. Whatever you do, avoid loan settlements. It would hamper your credit score today as well as tomorrow.