Thinking of loan settlement? Here’s how it can damage your credit score and future borrowing

When facing financial difficulties, repaying a loan on time can become challenging. In such situations, borrowers often consider loan settlement as an option. While settling a loan may provide short-term relief, it can have significant long-term consequences, especially on your credit score. Let’s take a closer look at what loan settlement really means and how it can affect your creditworthiness.

What is personal loan settlement?

A personal loan settlement is an agreement in which the lender accepts one payment that is less than the total amount owed. This usually happens when the borrower shows they cannot repay because of a job loss, unexpected medical issues, or other serious problems.

This is not the same as closing out a loan, however. A settled loan has a negative mark on your credit score, whereas a repaid loan has a positive one.

Will your credit score go up if you settle a loan?

Your credit score will not increase as a result of settling your debt. In fact, it will do the opposite. When credit bureaus see a loan that has been “settled,” they see a negative credit event. This negative credit event can hinder your ability to borrow money in the future, as it will remain on your record for up to 7 years. Lenders can deny your applications for a credit card or loan, or lend you money, but at significantly higher interest rates.

How much can a settlement hurt your credit score?

The following criteria will shape the damage to your credit score:

When should you consider loan settlement?

Settling your loan should only be your last option under the following circumstances:

1. You are in serious financial trouble.
2. Your money source is gone.
3. You’ve exhausted your options, like restructuring or a moratorium.

Always seek to negotiate for deferment, lowered EMIs, or a longer repayment period before considering a settlement.

Can you improve your credit score after loan settlement?

Yes, you can, although it is time-consuming and takes some credit behaviour discipline. Here’s how:

In conclusion, while settling a loan may give you short-term relief, it can significantly hurt your credit score and financial reputation in the long term. Be sure to think through all the possibilities before taking one. If you must settle, make every effort to pay the settled amount in the future and rebuild your score slowly.

Disclaimer: Mint has a tie-up with fin-techs for providing credit, you will need to share your information if you apply. These tie-ups do not influence our editorial content. This article only intends to educate and spread awareness about credit needs like loans, credit cards and credit score. Mint does not promote or encourage taking credit as it comes with a set of risks such as high interest rates, hidden charges, etc. We advise investors to discuss with certified experts before taking any credit.