Loan Settlement and How it Affects Your Credit Score

Loan Settlement and How it Affects Your Credit Score

What is loan settlement?
Loan settlement or Debt settlement is the process of paying off an outstanding debt to a creditor or lending institution at an amount lower than what is due. The debtor agrees to pay through lump sum payments, a repayment arrangement or a combination of both.

What is the difference between loan settlement and loan closure?
Loan settlement is when you have negotiated with the lender to accept something lesser than what was originally owed. Loan closure, on the other hand, is when you have paid off everything that is due.

The amount that will be written off is determined by the gravity of the situation and the borrower’s repayment capacity. Because loan settlement is for a sum that is less than the outstanding amount, the status of the loan will be labeled “settled.” In contrast, if the borrower had fully paid off his or her existing debt, the status of the loan would be “closed.”

When should you consider loan settlement?
If you’re having financial problems and you’re making loan payments but not enough to cover the interest, your outstanding balance will grow larger as time passes. The same can happen if your lender is constantly charging late fees or administrative costs. The principal amount of the debt also increases because this money goes toward paying off those extra charges.

In this scenario, you can ask the lender to extend your repayment term, re-examine your monthly payment amounts so that it is more convenient for you to make payments on a regular basis, reduce the interest rate, or at least waive off the interest for as long as possible. However, this is not easy and banks will seldom accept these options.

If none of these options work, you are better off negotiating and settling your debt with the bank rather than continuing to pay huge interest and other charges with no other solution in sight.

How does settlement affect your credit score?
Loan settlement does affect your credit report – as it is reported as “settled for less”. This will impact your credit score if it’s done within the first 12 months of your credit account opening. However, if you’ve had the account for more than 2 years and you settle it, this will not have much effect on your score. But whatever your lender reports about the account, whether it’s settled or written off, it will go into your credit report and remain for 7 years when it would then fall off your file.

The benefits of a loan settlement
Loan settlement helps you to come out of a debt trap when you have no possibility of paying your loans and the interest and penalties are piling up. Settlement eventually removes the debt from your credit report which is beneficial because it will improve your credit score in the long run. Your creditor or bank may also agree to remove late charges once the account has been settled and brought up to date, resulting in a better score as well.

How to rebuild your credit score after a loan settlement?
Establishing a good credit history is helpful in getting the favorable interest rates for your borrowing needs. In order to rebuild your credit score after a loan settlement, begin by paying any outstanding balances on your credit cards and other loans on time. If you have no other loans left, you can also try getting a small loan and start making timely payments on it. This will automatically start improving your credit score as the financial institutions see financial discipline in your transactions.

How to negotiate with your lender for a loan settlement?
If you don’t have enough savings and your income can’t cover the amount of your monthly payment while being able to meet all other expenses that need to be paid, then a loan settlement may be the only solution that works for both parties involved.

What you should do first is to take professional help to contact your lender and ask for a loan settlement. Be prepared to provide the necessary documents for this negotiation such as income certificates, bank statements or tax returns. Don’t forget to mention that you are ready to pay although it may take some time for you to be able to do so.

Tell them that you understand that this settlement can affect your credit score but ask about what options they have in settling this account with you without affecting your credit rating. You may also discuss payment arrangements such as the number of payments you can give them and what monthly or yearly amount you can put aside for those payments.

You may be offered a settlement deal such as paying the outstanding balance in full, paying it off over time, making reduced payments each month over a period of 12 to 24 months and possibly even an interest rate reduction which will help you save money in the long run.

When you receive your settlement offer, review it carefully to compare it with other offers that you may get from other financial institutions or lending companies. Accept the offer only when you are confident that you can pay the agreement amount as per the dates in the settlement plan.

Negotiating a settlement with the bank can be quite stressful and it is best to take professional help including legal support where required.

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