Navigating loan settlements: Exploring pros and cons you should know

Loan settlement can help struggling borrowers pay off debt faster, but it can also damage credit, be complex to negotiate and involve fees.

Most people will take out many loans in their lifetime for two primary reasons: to improve their quality of life or to deal with unexpected events. Loan settlement is an option that everyone should be aware of, as it may be our last chance to avoid defaulting on a loan.

Highlights

• Loan settlement offers quicker debt relief for struggling borrowers with the added benefit of potential credit enhancement.

• However, cons encompass credit score decline, negotiation complexity, and possible fees.

• Secured loans aren't ideal for settlement; personal loans and credit card bills are suitable targets.

What is a loan settlement?

Borrowers typically pay the total outstanding amount and the previously agreed-upon interest on the loaned amount. However, in extreme financial duress, borrowers can request lenders to settle their accounts for a one-time lump sum payment at a discount on the total amount.

Which loans should you settle?

It is not advisable to settle secured loans, as lenders can repossess the underlying assets. This makes personal loans, business loans, and credit card bills suitable targets for loan settlements.

What is the loan settlement process?

There is no fixed amount or percentage of the outstanding amount for loan settlement. It depends solely on the lender and your negotiation skills. Based on the maximum amount you can pay back and the negotiations, you may be asked to pay anywhere between 15% - 100% of the total outstanding amount as a lump sum.

After the negotiation, you can pay the settlement amount as a lump sum or set up a payment plan to settle the new debt within a reasonable timeframe.

Also Read: Know your rights as a loan defaulter

How does loan settlement impact credit scores?

Loan accounts closed with loan settlements are marked as "settled" by lenders. Then, they are reported to credit information bureaus, such as TransUnion CIBIL. 75-100 points are deducted from the CIBIL Score, depending on the settled amount.

When can you take a new loan after completing a loan settlement?

It takes seven years for settled loan accounts to be erased from your credit reports. To begin with, you can apply for a secured credit card (secured against properties) to get an interest-free 25-30 day repayment window on the credit card. You can rebuild your credit score by repaying the credit card EMIs on time.

Also Read: This is how you can increase your credit score in 30 days

The bottom line

Debt repayment obligations can sometimes become a slowly tightening noose around a person's neck. Loan settlements are a much-needed lifeline in such situations.

Disclaimer: The information in this article is intended for general informational purposes only and should not be construed as financial advice. Readers are advised to do their research and due diligence before making financial decisions. 

Click here for more articles on loans.