How to settle bank loans and private loans?

Summary

Loan settlement is a deal with your lender or bank to pay off part of the loan amount, usually because you cannot pay back the entire loan due to financial constraints. It is also referred to as loan settlement and can relieve you of your debt burden, but it has some risks associated with it, mostly to your credit score.

Both private and bank loans are payable, though in different ways. Banks mostly have a process where they discuss your financial health and make a one-time settlement proposal. Private loans, which come from individuals or finance companies, have lenient terms and are sometimes negotiable directly. But whichever way, always be truthful with your stand and keep all letters in writing.

Loan settlement must be resorted to only when all other means, be it restructuring of the loan or assistance from family, are not feasible. It saves you from court proceedings or harassment by recovery personnel, but it also reduces your CIBIL score and remains in your credit report in the years to come. It can make new loans in the future hard to obtain.

Introduction

Today, taking a loan has become the order of the day. People take loans for different reasons, like buying a house, establishing a business, studying further, or in a medical emergency. Loans are either taken from banks or from individual lenders. All is fine in the beginning when we can pay the monthly EMIs on time. But sometimes, due to unexpected factors like loss of job, health problems, or financial losses, it becomes difficult to repay the loan. 

Loan settlement is simply negotiating with the lender to pay some percentage of the sum you owe and settle the loan in full. The lender or bank usually extends it when they see that the borrower is not in a position to repay the whole loan owing to unavoidable monetary problems. Such a settlement is generally less than what is outstanding against the loan, and upon settlement, the loan account is closed. 

There are certain processes followed by banks and financial institutions to settle loans. They can request evidence of your financial situation, and depending on that, they might provide an option for a one-time settlement. Private loans, borrowed in most cases from individual lenders or NBFCs, may have different and less formal procedures. 

In this article, we will take you through step by step how to settle your bank loans and private loans smartly and legally. We will explain what a settlement is, when you should consider it, what you need in terms of documents, how to negotiate with the lender, and what effect it can have on your credit report. We will also discuss loan settlement versus loan closure, negotiating with lenders, and what to do to avoid getting into a debt trap all over again.

What is a Bank Loan?

A bank loan is borrowed funds from a bank when you need help to purchase something that requires a lot of money, for example, a house, a vehicle, starting a business, or school charges. The bank gives you the money, and you pay back later, probably monthly, in EMIs (Equated Monthly Installments). Besides the borrowed amount, you also pay some amount of money known as interest.

This is how the bank earns profit. When the bank gives you a loan, initially they check your income, profession, credit report, and all to make sure that you can repay. Banks have different loans like personal loan, housing loan, car loan, study loan, etc. Taking a loan from the bank can be beneficial, but keep in mind that you should only borrow what you will be able to repay in due time to avoid any trouble later on.

What is a Private Loan?

A private loan is funds borrowed from someone or a private organization instead of a bank. Private lenders can include family, friends, moneylenders, or private financial organizations. Private loans are easier to acquire than bank loans because they may not require too many checks or documents.

But they charge higher interest rates to lend, and the conditions are not always as explicit or safe as bank loans. Some private lenders may even coerce you into early repayment. That is why you have to be cautious and read everything carefully before availing of a private loan. Always take only what you need and see that you repay on time.

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 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 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 documents are required to do a Loan Settlement?

Let us know what documents are required 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 employed)
• 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 troubled 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 seen 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 reduced 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.

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

Securing a private loan or a bank loan is a significant financial choice. Most individuals encounter loan issues because of loss of job, illness, business loss, or unforeseen expenses. When you cannot repay your loan, the debt continues to increase, and it becomes more difficult to cope with. Under such circumstances, loan settlement can be an option to ease your burden. It involves speaking to your lender or private bank and asking them to take a reduced amount instead of the entire loan, and then closing the loan account.

While this may look like an easy way out, you should realize that loan settlement should be the last option for you. In case you can repay the entire loan or reschedule the loan, that’s always better. Loan settlement will negatively affect your credit score, and this will get you into trouble in the future when you try to borrow a new loan, credit card, or even get a job in some cases.

Always attempt to communicate freely with your lender or bank if you have difficulty repaying. Don’t avoid or refuse their calls. Disclose your situation. Most banks and some private lenders will assist you if they understand that you are serious and genuinely in financial distress. Maintain all records of your communication, and ensure that you obtain a proper No Dues Certificate or Settlement Letter upon closing the loan. This will safeguard you from future legal or financial issues.

Frequently Asked Questions (FAQ’s)