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Loan settlement is a common term used in the banking sector. This is a loan repayment method that helps a borrower in settling a loan at a lower sum than the total amount due. However, this method negatively affects your CIBIL score.
If you are an entrepreneur looking for a business loan it is necessary to know loan settlement meaning, process of settling a loan and how settling a loan affects your CIBIL score.
What is loan settlement?
Loan settlement is done when a borrower finds himself/herself in a financial crisis and unable to repay the loan. It is the process where the lender agrees to reduce the loan amount to help the borrower easily pay off the loan during financial hardship. This reduced loan amount must be paid in full by the borrower for settling the loan.
Does settling a loan impact your CIBIL score?
Bank loan settlement does impact your credit score. As you know, if you pay up your EMIs on time and pay off the loan as per the time in the loan agreement your CIBIL score increases. However, if you default on a loan your CIBIL score reduces.
When you settle a loan, your lender will notify credit rating agencies including CIBIL. The credit rating agency considers loan settlement as a negative development in the loan repayment history. Therefore, the agency slashes your credit score.
According to banking experts including Bajaj Finserv and BankBazaar, CIBIL can cut your credit score by 50-100 points. So, if your CIBIL score is 750 points it will be reduced to 650 points after loan settlement.
Moreover, after settling a loan your credit report will indicate this loan repayment status as ‘Settled’. This status remains on your credit report for 7 years. This may stop financial institutions from lending money to in the future. Even if they sanction a loan despite the settled status, the institution might charge you a high interest rate to cover the cost of risk involved in lending money to you.
Points to note for loan settlement
- Any loan that is due more than 90 days is classified as a Non-Performing Asset (NPA) by the bank. If the borrower defaults for more than 180-270 days after the payment date, the bank may write off the loan.
- Loan settlement can happen before or after the write-off.
- If the settlement happened before the write-off, the credit report will read “settled”. If the settlement happened after the loan was written-off, then the credit report will be read “post-write-off settled”.
- Both these statuses on your credit report will impact your credit score negatively. This will lead to lenders refusing your loan application as these labels are considered bad loan repayment behaviour by the banks.
Improving credit score after loan settlement
If your credit score has been affected after the loan settlement, you can try increasing your credit score. This will increase the chances of you getting a new loan. Here are some ways you can increase your credit score if a loan settlement has impacted your score:
- If you have other active loans, make sure that you pay your EMIs on time without missing the due date.
- Don’t exhaust the limit of your business credit card. Your credit utilisation ratio must be 30% or below.
- If you have accumulated debt on your business credit card, you can try to pay up more money than the minimum amount due.
- Don’t apply for a new loan soon after the loan settlement process. Wait until your financial crisis is over and your profit and loss sheet indicate a positive business cash flow before you apply for a new business loan.
Also read: Can I obtain a loan without CIBIL score?
Removing the settled status from your credit report
If your credit report shows ‘settled’ status it is possible to remove the status to increase your chances of getting a business loan sanctioned. Follow these steps to remove the status:
- Pay up the reduced loan amount in full as mentioned in the loan settlement agreement
- Obtain a no-objection certificate from your lender
- Submit the certificate to credit rating agencies
Once you submit the no objection certificate, the credit rating agencies will automatically update your loan account status from settled to closed. Make sure that you check CIBIL report after a few weeks to confirm whether the status has been updated.
Even though financial hardships are common, you must try to pay off your loan on time to avoid a loan settlement. In case you are not able to pay up a loan, you can ask your lender to put off your EMI payments for a few months and agree to start paying the EMIs after this period is over.
If you are looking for a business loan at low interest rates visit Tata nexarc. We can match you finance requirements with business loan products from reputable lenders across India.
Also read: What is the difference between credit score and CIBIL score
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