Loan settlement

settlement of loan

3 years ago, Mr Rangaswamy went through a difficult time with his business and lost a lot of money. At that time, a number of creditors, including banks, were knocking at his doors regularly to collect their money.Prashant sold the house that he had bought from his earnings to pay off his loans. Since the outstanding on his loans was higher than the selling price of the property, he had to settle a few bank loans. Mr Rangaswamy was relieved that he had managed to get the creditors off his back. He is satisfied that his peer group appreciated his efforts and held him in high regard even though he had to sell his property. After the struggle and hard work of the last 3 years, his business started to expand. He decided to apply for a business loan so that he could expand his operations. While he has the ability to service the loan, but he has entered into settlements in the past and an underwriter would be weary of extending credit to a person who has borrowed money in the past and has caused losses to the lender. In this case, there could be a query as to why someone, who displayed strength of character by repaying his loan through the proceeds of his house, should be declined on a loan application. From an underwriting perspective, Mr Rangaswamy has not repaid in full. He settled his loans and the lenders lost money on credit facilities extended to him. This casts a shadow on Prashant’s Credit Character: the likely assumption is that future loan disbursals may have the same outcome (settlement) as had happened earlier.

What is a settlement ?

With reference to a credit facility, a settlement is an official agreement between creditor and debtor to resolve over dues. This status signifies that there was a mutual agreement between the borrower and lending institution. As part of this arrangement, a part of the outstanding on a loan is waived to close the account

In this context, it is important to note that even those who have “settled” and “zeroised” (the outstanding on the credit report is updated as zero) their accounts, have to work with the lending institutions to make good on the waivers that were offered during the settlement. The settlement amount is an amount that both the lender and borrower agree upon for the closure of the account. However, the reality is that since the borrower has not paid the complete amount, the lender has incurred losses on this transaction. These accounts are reported to the credit bureaus by the lending institutions as “SETTLED” accounts. Such settled accounts have a negative impact on a person’s credit profile. Thus, even those who have settled a default are likely to have to pay back to the bank.

Therefore, settling an overdue account does not improve your credit profile. As a matter of fact, a “settlement” represents a negative remark on a credit report and adversely impacts the credit underwriting decision.

Advantages of a settlement

  1.  Zeroises the loan account. Lenders cannot ask you for more money
  2.  Collection agents stop making visits to your house
  3.  Everyone is happy given that this is a compromise situation

Disadvantages of a settlement

  1. Credit bureau gets updated with a settlement flag (‘S’), which makes lenders wary of lending to such borrowers
  2.  Even those who have settled a default are likely to have to pay back to the bank if they want a clean shit on the credit report