What is the Relation between Loan Settlement and Insurance?

Summary

Loan settlement and insurance are two financial products that can help people pay off their debt and secure their future. Loan settlement is a process under which a borrower who is unable to pay the loan in full negotiates with the lender to pay a smaller amount as a final payment. It assists the borrower to close the loan account and not incur further penalties or prosecution, although it will have an impact on their credit rating.

Insurance, however, is a precautionary process that provides money in the event of unforeseen circumstances like death, disability, sickness, or loss of assets. There are numerous forms of insurance, including life insurance, health insurance, motor insurance, and loan protection insurance. One of the most significant links between loans and insurance is that some insurance, particularly loan protection insurance, insures the loan amount if the borrower does not repay the loan in case of death or disability. This saves the borrower’s family from being burdened with the unsecured loan, and the lender also gets their money back.

While purchasing an insurance policy, one must consider coverage, premium cost, claim process, and insurer’s credibility. Insurance can be a solid column in loan management and (Loan Settlement and Insurance) settlement planning. Insurance is a buffer that jumps into action at the time of financial crisis and reduces the risk of defaulting on loans.

Introduction

However, because of job loss, sickness, accident, or personal issues, individuals are unable to repay their loans at the right time. Under such circumstances, loan settlement and loan insurance step in. Both deal with assisting the borrower, but in a different manner. To know how they are related, we must first know what loan settlement and loan insurance are.

Loan settlement is a procedure in which the bank and the borrower mutually agree to settle the loan by paying less than the amount that was originally due. For instance, if someone has borrowed ₹5 lakh but is not able to repay the same, the bank can opt to “settle” the loan for ₹3.5 lakh. That is, the individual pays ₹3.5 lakh, and the loan gets settled. This also negatively impacts the credit rating of the individual, and it becomes harder to obtain loans in the future.

Loan insurance, also referred to as loan protection insurance, is an insurance cover that guarantees repayment of the loan in case of unexpected events such as death, disability, or loss of employment of the borrower. In case the borrower becomes seriously ill or dies and is no longer able to work, the insurance company pays the loan amount remaining to the bank.

Here in this article, we will understand in detail how loan insurance works, when you can opt for it, what during loan settlement, how both of them impact your CIBIL score and future, and how you can safeguard yourself while opting for any type of loan. If you are aware of the relationship between the two, it will help you make wiser and safer financial choices.

What is insurance?

Insurance is one way of protecting yourself from having gigantic money problems in the future. It is a safety measure. You pay a little bit of money regularly to an insurance company, and the company will assist you in case something terrible happens, such as having an accident, getting sick, dying, having your house catch fire, or losing valuable possessions.

For example, if you are under cover for sickness and you get sick, the insurance company will help cover your hospital bill. If you have insurance for your vehicle and your car is damaged in an accident, the company will pay for repairs. This helps you save money and remain safe. Therefore, insurance gives you a sense of comfort and relief when times get hard.

How many types of insurance are there?

There are several types of insurance, and they all have the purpose of protecting you against different risks or uncertainties. The most familiar types of insurance are:

• Health Insurance: It protects against healthcare expenses, including doctor visits, hospital stays, surgeries, and prescriptions. It reduces the cost of healthcare.

• Life Insurance: It pays money out to your loved ones or relatives when you pass away. It can help cover funeral costs or living expenses.

• Car Insurance: This protects you against the loss of money if your car gets damaged, stolen, or if it gets into an accident. It also pays for someone else’s damages or injuries to other people’s property.

• Home Insurance: This covers your house and contents in case of loss by fire, theft, or natural disasters. It also protects you against liability if someone gets hurt on your property.

• Travel Insurance: This covers you while traveling, covering such issues as trip cancellations, medical emergencies while overseas, lost luggage, or delayed travel.

• Accident Insurance: This covers you in case you get injured in an accident, while working, while traveling, or in your home.

• Disability Insurance: This compensates to cover part of your income should you be unable to work due to an injury or a disability.

• Property Insurance: This covers property, such as buildings, against events like theft, fire, or natural disasters.

• Business Insurance: This is for business owners and covers against risks of running a business, such as loss of property, lawsuits, or harm to employees.

• Pet Insurance: This covers medical expenses incurred by pets, including vet visits, surgeries, and medication.

Why is it necessary to take insurance?

It is necessary because it can safeguard you from unforeseen financial loss. Life is never certain, and accidents, illness, or catastrophes can happen at any moment. Without insurance, you would have to pay for these things yourself, which can be very costly.

For example, if you fall ill or get hurt, the bills can be quite expensive. However, if you have health insurance, it is not your job to pay the bills yourself. Similarly, if your car is damaged in an accident or your home is set on fire, it will be covered by your insurance.

In short, insurance gives you reassurance and confidence. It minimizes the impact of life surprises on your wallet and prevents you or your dear ones from incurring a money crisis in troublesome times. You would otherwise have to face risks without coverages, and hence it is an excellent addition to individual financial planning.

What things should be kept in mind while purchasing an insurance policy?

When purchasing an insurance policy, keep in mind the following so that you purchase the appropriate coverage:

• Know Your Needs: Before purchasing an insurance policy, understand the type of coverage that you need. Do you need health coverage, life insurance, or car coverage? Think about your situation right now, your family, your health, and your monetary objectives.

• Compare Various Policies: Don’t buy the first policy you see. Compare three or four policies from various companies to see what is covered most, helpful, and expensive.

• Premium Value: The premium is what you pay repeatedly for the policy. Make sure the premium is reasonable and within your means. Also, make sure there are no extra fees, such as taxes or unexpected fees.

• Coverage and Benefits: What does the policy cover? Does it cover all the benefits that you need, for instance, hospitalization, surgery, or accidents? Make sure the policy covers you adequately for your needs.

• Claim Process: See how convenient it is to claim. A good policy should have a simple and quick claim process. Make sure the company has adequate staff with quality customer service.

• Policy Terms and Conditions: Carefully read the fine print. It’s necessary to understand the terms, exclusions, and conditions of the policy. Check for any clauses that could reduce your coverage or make it more difficult to collect benefits.

• Company Reputation: Select an insurance company that is well-established and reputable. Check reviews, ratings, and customer feedback to see that they have a history of excellent service and paying claims.

What is the connection between insurance and a loan?

Insurance is responsible for covering these risks and can protect the borrower as well as the lender.

Here’s why insurance and loans are related to each other (Loan Settlement and Insurance):

• Loan Protection Insurance: It is an insurance product that can settle your loan if something unexpected happens. For example, if you take a loan and then fall sick or get fired, the loan protection insurance steps in to help with loan repayments.

• Life Insurance with a Loan: Some lenders will require you to have life insurance when you borrow, especially for significant loans like mortgages. The rationale is that when the borrower dies suddenly, the death benefit from the life insurance can be utilized to settle the loan so that the borrower’s family or loved ones do not have to assume the burden of repaying the debt.

• Home Loan Insurance: For home loans, banks typically offer home loan insurance or mortgage insurance. This covers the outstanding balance of the loan in case of the death, disability, or any serious health issue of the borrower.

• Car Loan Insurance: As in the case of home loans, when one is taking a car loan, the lender can advise or require that you acquire insurance on the car in case there is an accident, theft, or destruction.

• Security for Lenders: Insurance serves to reduce lenders’ risk. When the borrower has insurance, the lender knows that the loan will be paid back even if the borrower becomes financially troubled. This reduces lenders’ risk, and sometimes even helps the borrower get more favorable terms on a loan or lower interest rates.

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 documents are required to do a Loan Settlement?

Let us know what documents are required for a Loan Settlement and Insurance.

ID Proof

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

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)

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)

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.

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?

Settlement Offer Letter given by the bank

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

What to do before doing a Loan Settlement?

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

• 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.

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 and Insurance are:

• 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.

• 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.

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

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

• 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.

• 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.

Conclusion

Lastly, loans and insurance (Loan Settlement and Insurance) are two financial tools that walk hand-in-hand to provide protection and security in times of uncertainty. Just as loans give loans to enable one to buy a house, car, or settle individual bills, they also bind one to pay back in due time. However, life is full of uncertainty, and unexpected situations like illness, accidents, or even death can make it impossible for a person to pay back the loans. This is where insurance helps.

Insurance provides a safety cushion, so that in case something goes wrong, either the borrower or his or her family members are not left struggling to pay back the loan. Loan protection insurance, life insurance, and other insurance products linked to loans help repay the outstanding loan, preventing both the lender and borrower from financial destruction. For example, it covers mortgage repayment if the borrower passes away, and loan protection insurance helps repay the same in the event of sickness or redundancy.

Borrowers also like to have the right insurance since the lender is left with a secured debt rather than an uncertain one. It gives peace of mind, whereby the borrower’s family will not be burdened with loan payments in case of an emergency. Additionally, insurance can be considered a sensible way of protecting your assets and your financial future as well. It ensures that you will not find yourself in a situation where your family members or loved ones will have to bear the weight of your financial obligations.

Frequently Asked Questions (FAQ’s)