How does settlement happen after a loan and credit card default?

Summary

When a borrower does not repay a loan or credit card, it is because they are unable to pay the amount due, typically due to financial setbacks like loss of job, sickness, or personal issues. A Loan settlement is thus employed to clear the debt amount, where the lender accepts a lesser payment as the last payment for the debt. This process relief is experienced by borrowers who cannot pay the entire amount but don’t want any further legal processes or collection calls.

Settlement starts when the borrower visits the lender, explaining their situation and requesting a reduced amount. The lender thinks over the case, and if they believe the borrower is not capable of paying back the entire debt, then they can issue a settlement proposal. This could be in terms of a lump sum or a reduced repayment plan. Once the borrower pays the settlement amount, the bank issues a settlement letter acknowledging that the debt is settled.

However, debt settlement comes at a price. One of the severe drawbacks is the impact it has on the credit score of the borrower. The “settled” status on the credit report means that the borrower did not pay the full amount, and this complicates obtaining loans or credit in the future. Settlement should only be done as a last resort after all other means of repayment are deemed unavailable.

Introduction

When an individual takes a loan or purchases an item on a credit card, they vow to return the amount on time. But sometimes, because of personal or financial problems like job loss, illness, or business downfall, individuals fail to repay their EMIs or credit card bills. This is called a loan or credit card default. It causes a great deal of trouble and stress, with banks and recovery agents starting to follow up periodically for the amount due. 

Settlement happens when the bank and the borrower come to a mutual agreement on a common resolution for repaying the loan or credit card. In plain terms, the bank compromises to accept a lower amount than was initially owed. For instance, if one is required to repay ₹1,00,000 but cannot come up with the entire sum, the bank will compromise to accept ₹70,000 and settle the account. This is not a repayment in full, but in part.

The settlement process often starts when the borrower explains his or her financial situations to the bank and formally requests a settlement. On the reading of the case, if the bank feels content that the borrower actually cannot repay the total amount, then they can agree to one-time settlement or payment on a decreased level. Once the deal is mutually agreed, a settlement letter is issued, which acts as proof that the account is being closed.

In this article, we will explain in great detail how settlement happens after a default on a loan or credit card. We will also discuss when and why you need to settle, how to negotiate with the bank, what papers you will require, and how it will affect your credit score.

What is a Loan Settlement?

Loan Settlement is a process in which you negotiate with your creditor to forgive a part of the outstanding amount on your Loan by making a lump sum payment. It is an agreement that you make with your card issuer as a last resort when you see that your Loan debt is increasing.

This can happen due to many reasons, ranging from unnecessary spending to careless spending habits. When your debt increases, the interest on it also increases, which can make it difficult for you to repay the outstanding amount. If you do not see any way out of this, then you can recommend a Loan Settlement.

What are the reasons for doing a Loan Settlement?

Below are some common reasons:

• If a person loses his job, stops a source of income, or suffers huge losses in business, then it may be difficult to repay the loan on time.

• There may be a shortage of money to repay the loan if the expenses suddenly increase due to a major illness or medical emergency.

• Many times, a person has the burden of more than one loan, which becomes difficult to repay on time.

• There may be problems in repaying the loan due to any natural disaster, accident, or any major crisis in the family.

• If the interest rate of the loan is very high and there is a problem in repaying the installment, then a Loan Settlement is resorted to.

• Many times, a person is not able to manage his expenses and income properly after taking a loan, which causes problems in repaying.

What to do before doing a Loan Settlement?

Below are some steps that should be followed before a Loan Settlement:

• First of all, check your income, expenses, and all other debts properly. Know how much you can repay.

• Before a Loan Settlement, share your problem with the bank or lender. 

• Sometimes, they can offer you a better solution, such as reducing the EMI or increasing the loan term.

• Contact a financial advisor or expert. They can help you make the right decision and explain how a Loan Settlement will affect your credit score.

• If you decide to do a Loan Settlement, read the terms and conditions given by the bank carefully. Make sure that you are not being charged any hidden fees.

• Doing a Loan Settlement can reduce your credit score. This can make it difficult to get a loan in the future. Make a decision keeping this in mind.

• Loan Settlement should be the last option. Before that, consider other options like refinancing, reducing EMIs, or asking family and friends for help.

What documents are require to do a Loan Settlement?

Let us know what documents are require for a Loan Settlement.

1. ID Proof

• Aadhar Card
• PAN Card
• Passport
• Driving License
• Voter ID

2. Address Proof

• Aadhar Card (if it has the correct address)
• Electricity or Water Bill
• Copy of Bank Passbook or Bank Statement
• Rent Agreement (if you live on rent)

3. Income Proof (if required)

• Salary Slip (if you are employee)
• Bank Statement (last 6 months)
• Copy of Income Tax Return (ITR)
• Business Documents (if you are a businessman)

4. Loan Statement

You will have to provide the Loan statement to give the correct information about your outstanding balance. The bank can also generate this statement itself, but sometimes they ask you for a copy of it.

5. Settlement Request Letter

If you are approaching the bank for settlement on your own, you will have to give a written Settlement Request Letter in which you can explain:

• Why do you want a settlement?
• What is your financial situation?
• How much can you pay as a one-time payment?

6. Settlement Offer Letter given by the bank

When the bank agrees to the settlement, it gives you a Settlement Offer Letter. Read it carefully and confirm the amount and terms mentioned in it.

How to apply for a Loan Settlement?

If you are unable to pay your Loan dues and are trouble by heavy interest rates, a Loan Settlement can be a possible solution. Under this process, the bank or Loan company can waive off part of your total outstanding amount and give you the option to make a lump sum payment (One-time Settlement). However, this can affect your CIBIL score, so adopt it only as a last option.

Step-by-step process to apply for Loan Settlement

• First of all, decide that you are not in a position to pay the entire Loan dues.

• Check your income and expenses and decide how much you can pay at most.

• Talk to the customer care of your bank or Loan company and tell them about your current financial situation.

• Ask for a settlement offer from the bank and start the conversation.

• The bank will propose a settlement amount, which will be lower than your outstanding amount.

• If you don’t accept this amount, negotiate with the bank and attempt to lower the amount based on your capacity to pay.

• After the bank and you reach an agreement on a specific amount, ensure that you receive a written settlement letter.

• It should explicitly state the settlement terms, payment dates, and other conditions.

• After completing the settlement, pay the amount in full within the given time.

• Get a No Due Certificate (NOC) or Final Settlement Letter from the bank after the payment.

• After the settlement, make sure the bank updates the “Settled” status in your CIBIL report.

• This can affect your credit score, so inculcate good financial management habits to improve it in the future.

What is the impact on the CIBIL score after a Loan Settlement?

A settlement can hurt your credit score. The impact can be see in the following ways:

• After the settlement process, your credit report records that you have “settled” your debt. This entry remains in your credit history for 7 years and can be viewed negatively by lenders or other creditors, which can affect your chances of getting a loan in the future.

• Since a settlement means that you have not repaid the entire debt, when you try to get a new loan in the future, banks may reject your application or offer you loans at higher interest rates by looking at your credit score and report.

• After settlement, if you have a Loan or other credit line, your credit limit may be reduce as creditors think you may be a high-risk customer.

• If your credit score drops, it may be difficult for you to get a loan, Loan, or any other type of credit facility. This can also affect your financial stability, especially if you face a financial emergency in the future.

• When you settle with your bank, you are not paying off the entire debt, but a certain amount that is less than the principal amount. This is viewed negatively by the credit bureaus, as it shows that you have been unable to repay your debt. As a result, your credit score may drop.

How does settlement happen after a loan and credit card default?

But even after a default has been committed, borrowers of loans or credit cards can recover the debt with the lender. This is what happens after default:

Understanding the Default Situation:

If a loan or credit card installment payment is overdue for a prolonged duration, the bank considers the account “defaulted.” After a default for typically 3-6 months, the lender would initiate action through the courts of law and would start chasing the borrower to make payment. Then, the bank would start giving the borrower reminders, calls, and notices often.

Beginning the Settlement Process:

Settlement typically happens when the borrower realizes that they are unable to pay the full amount. In this case, they can approach the lender or credit card company and request a settlement. The borrower can inform the bank of their financial hardship, such as losing a job, family issues, or illness, and request that the bank settle the debt.

Bank’s Evaluation:

After a borrower is attempting to close the account, the lender shall scrutinize the same. The bank shall make provision for items, including the financial health of the present borrower, the borrower’s earnings, and how much needs to be repay in case of default. In case the bank is content with the idea that the borrower cannot pay back even the original principal amount, then the bank could enter into negotiations with the borrower, settling at below what the borrower originally had in hand.

Negotiation:

In some cases, the lender and the borrower will negotiate. The borrower will try to convince the bank to reduce the existing outstanding credit card or loan amount. Banks won’t lose the money, but in this case, might settle for something less so that the account is shut down and they avoid legal processes.

Lump Sum or Reduced Payment Agreement:

Subject to mutual consent, the lender can ask for a lump payment less than due. The bank may offer a deal in which the borrower gets lower payments in a series over a period. Once the borrower has made the agreed payment, the bank will record the loan or credit card debt as paid.

Getting a Settlement Letter:

Once the borrower has paid the outstanding amount, the bank shall issue a settlement letter. The letter is official acknowledgment the debt has been settle. The borrower shall keep the letter in a safe place for future reference purposes, as it is evidence the debt is clear.

Impact on Credit Score:

While settlement can release the borrower from further legal action, it will also hurt their credit record. Instead of having the credit card account or loan showing up as paid in full, it will show “settled.” This marks the account as part-paid, making it difficult to get loans or credit in the future. Banks will view a settlement as an indication that someone is having money problems.

Legal Consequences:

In some cases, if the borrower is not able to repay the debt, then the lender may go to court, i.e., file a case or attach assets. Nevertheless, most lenders would rather have a settlement as a way to recover at least some of the debt rather than go through a lengthy court process.

What are the advantages (Pros) of doing a Loan Settlement?

Let us know what the benefits of doing a Loan Settlement are:

• Mental tension grows through rising debt and bank calls. On settlement, you are free from this concern, and you may concentrate on a better financial status again.

• If your Loan dues have become very high, and you are unable to repay them, then a settlement can give you great relief.

• When you do not pay your Loan continuously, the bank can send a legal notice to you and can also send a recovery agent.

• The interest on Loans is very high, which can be up to 30-45% per annum. If you are not paying on time, the interest and late payment fees keep increasing continuously.

• While a settlement will bring down your CIBIL score, provided you exercise financial responsibility after the settlement and settle your other loans and bills punctually, you will improve your score over time.

• In a Loan Settlement, you pay a specific sum at one time, which settles your debt entirely. It may be helpful to the people who desire to come out of debt by increasing a little money at a time.

What are the disadvantages (Cons) of doing a Loan Settlement?

Let us know in detail what the disadvantages of doing a Loan Settlement are.

• Doing a Loan Settlement can spoil your relationship with the bank. The bank sees it as if you have not fulfilled your financial responsibilities completely, due to which you may face problems in banking services in the future.

• The biggest disadvantage of a Loan Settlement is that it spoils your CIBIL score. When you settle with the bank and pay a lesser amount instead of paying the entire dues, the bank reports it in “Settled” status. This status can remain in your credit report for up to 7 years, which may make it difficult to get a loan or a new Loan in the future.

• If you have done a Loan Settlement once, banks and other financial institutions may consider you a “high-risk customer”. This may cause problems in getting a home loan, personal loan, or business loan, or the bank may give you a loan at a higher interest rate.

• In some cases, when you go to take a loan from another bank in the future, the bank may ask you to repay the entire previous settlement amount after looking at your credit history. That is, if you had settled by paying Rs 50,000 on an outstanding amount of Rs 1 lakh, then the new bank can demand the remaining Rs 50,000 from you.

• If you have settled a Loan with a bank, then the same bank can refuse to issue you a Loan again in the future.

Conclusion

To repay a loan or credit card bill after default can be an interim relief for debtors who are unable to fulfill their financial obligations. While it seems an inviting choice, it needs to be remembered that the process has its own set of difficulties and consequences. The most prominent impact is on the credit score of the borrower.

The borrowers must know the terms and consequences well in advance while agreeing to a settlement. Having all this done in writing on paper, be it a settlement letter or any other document, is just as vital and creates evidence of the settlement of debt. Negotiating terms carefully with the lender and receiving as much as possible in such arrangements is not sufficient; even more importantly, there has to be caution about falling into debt in the coming years.

Among the most important facts to remember is that paying in full is not the same as debt settlement. While it may be a temporary solution, it does not erase the reality that the borrower was not able to keep up their original repayment conditions. This is the reason why borrowers need to practice improving their financial habits, doing their budget properly, and trying alternative solutions before they can settle.

Frequently Asked Questions (FAQ’s)