Loan Settlement is the formation of an agreement between a borrower and a lender to settle the loan amount for less than what is owed, due to circumstances that has incapacitated the borrower to repay the complete amount. The process involves negotiation between the borrower and the lender to reach a compromise, formation of an agreement, completion of the revised payment by the borrower, and resolution wherein once the payment is made, it is understood that the debt owed is complete.
The credit score helps lenders in getting a visual picture of the probability of a borrower repaying the borrowed money. It is based on factors such as the payment history, length of credit, types of credit, new credit inquiries and management of credit mix.
Applying for loan settlement can affect the credit score based on certain factors. Settling a loan can have positive or negative impacts. When a loan is successfully paid in full, it can have a positive impact as the long-term debt burden is reduced. However, if the loan amount is settled by paying less than what is owed, it can have a negative impact as it is shown as a “settlement” in the credit report. It must be noted that, any such impact on the credit score depends on the specific financial situation and how the settlement is reflected. Keeping a close watch on any changes made to the credit report can prove beneficial in such assessment and understanding.
Initially, when any application for credit is put forward, a “Hard Enquiry” is initiated, wherein the lender analysis the credit report of the borrower. This temporarily lowers the credit score of the borrower, and has the maximum impact in the first few months. Subsequently, after a period of 2 years, the mention of hard enquiry is removed from the credit report.
The credit utilization ratio also has a certain impact over the credit score. It is the ratio between the credit card balance and the credit limit. The settlement of loan lowers the overall debt burden of the borrower, which has the potential of improving the credit utilization ratio and thus the credit score. However, if the change to the overall debt after settlement is minimal, the improvement in the credit utilization ratio might not be significant.
The credit history of the borrower is important and is crucial to the credit score. It refers to the analysis of the number and amount of times a loan has been availed by the borrower, and the payments made thereof. If the loans have been paid off in full and on time and the credit has been managed responsibly, a settlement has less of an impact on the credit score. However, on the contrary, if the credit history of the borrower shows a series of lapse in payment of loans, any settlement that follows, would have a greater impact on the credit score.
Settling a loan has both long-term and short-term impact on the credit score, and the extent of such impact varies depending on factors discussed above and more.
