Does Loan or Credit Card Settlement Affect Your Credit Score?

calculationYou have been struggling to make your credit card or loan repayments for a few months now. Bank officials and recovery agents have been breathing down your neck to make these payments. You have explored all potential options, but nothing has materialized. You have grown tired of all this. You decide to approach your bank for Settlement.

What Does Loan/Credit Card Settlement Mean?

Settlement means that the bank agrees to accept less than what is due. For instance, your credit card outstanding is Rs 5 lacs. It takes Rs 3 lacs and closes the loan/card account. Essentially, the bank forgets about the remaining amount. No interest payments or penalties for this account in the future.

Do note settlement is only for unsecured loans. For secured loans, the banks won’t be so kind to accept less than the due amount. They will first sell the security and if there is still some portion of debt to be repaid, they can think about settlement.

Does Loan/Card Settlement Affect Your Credit Score?

Though I have read conflicting accounts of whether debt settlement affects your credit score, I am more inclined to believe that your credit score will be affected if you opt for debt settlement. After all, you haven’t made the complete payment to the lender and you must be penalized for this.

You must also note that nobody goes for debt settlement at the first signs of debt trouble. For instance, you will not call your bank to settle your loan/credit card debt just because you feel you won’t be able to pay next month’s EMI or credit card bill. Even the bank won’t agree to your offer (or make a settlement offer) so soon. It is only when your debt troubles are obvious that the bank will agree to take a haircut. Banks don’t indulge in charity. Unless they have lost hope of full recovery from you, they won’t agree for a settlement. Therefore, your credit score would have already taken a hit due to prior non-payments. Whether debt settlement affects your credit score ever more (over and above the hit already taken due to non-payments) is a question for me too. Credit bureaus have proprietary score calculation method and may treat settlements differently.

At the same time, credit score is just one part. Your credit report contains a whole host of other details. If you opt for settlement, the relevant account will show as “Settled” in your credit report. The banks will clearly dread this and won’t be comfortable in lending to you in the future. Therefore, your chances of getting a loan in the future will go down. You may be charged a higher interest rate for any loans in the future. Your loan eligibility may also drop due to a prior debt settlement. For this reason, settlement must be your last resort.

How Much Would the Bank Settle For?

Difficult to comment. May vary from case-to-case basis. Clearly, the bank will not settle for a very low amount. And there is no reason why it should. It would want you to pay the maximum you can pay. If your finances are clearly messed up, the bank would agree to a bigger cut. The bank would (and should) also look at your intent too. It cannot happen that you have loads of assets and you are not selling them to repay the loan/credit card debt.

It is easy for us to portray banks as evil. However, they are playing by the rules. We have reneged on the terms of contract. The bank does not want to be short-changed either. That the corporate borrowers short-change them so regularly is a different matter altogether. They can’t let retail borrowers get away so easily.

The banks may have internal policies about settlements. However, as I understand, the extent of haircut (loss to the bank) will also depend on a case-to-case basis. There won’t be any well-defined formula. You can expect extensive negotiation too. As a borrower, you know that a settlement is a settlement. You know that your credit report will reflect this account as Settled, irrespective of the quantum of the haircut. The less you pay, the better it is for you. Well, the banks know this too, and they would want to maximize their payment.

What Aspects You Must Keep in Mind?

Get everything in writing. Don’t go by promises made by customer care executives over phone. In financial services industry (not just banks), they will promise the world to you over phone to get you to part with money. You don’t want to part with your money and then realize that the funds have been used to settle the balance in a regular way (and not as settlement). In that case, you will still have debt outstanding and the bank’s interest and penalty meter will keep running.

Insist on settlement offer over e-mail from official IDs or physical letters. In case of physical letters, do check that the letter is on the letter head, has bank seal and a reference number. Essentially, you must ensure that the letter is genuine. You can scan the letter and e-mail the letter to the customer care and ask them to confirm if the letter has been issued by the bank. Fortunately for you, banks must keep records of such letters. For quick response, you can always escalate to higher management.

Don’t pay by cash. Pay using cheque or demand draft or net banking. While handing over the cheque, insist on a letter that contains the details of your payment and the purpose of payment.

To put it in a crisp manner, once you have mentally prepared yourself for the settlement and the associated consequences, ensure that you are not short-changed by the bank. Don’t go by words, go by the letter. Get everything in writing.

Settlement is your last resort. A prudent borrower must never find himself in this situation. Don’t borrow more than you can afford to repay. Look for early signs of debt trouble and take proactive remedial action.

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