Don't leap at that one-time loan settlement

Because a settled account will do more damage to your credit history than you can imagine.

You may have taken a loan with a certain plan for repayment, but life may have thrown a spanner in the works, and you now find yourself unable to meet your repayment commitment.

At a time like this, if your bank offers you a one time settlement (OTS), you would probably leap at it, but did you know that it can take a toll on your CIBIL score?

State Bank of India, India's largest commercial bank, is currently holding a 'Rin Samadhaan' or a loan resolution week, whereby it is hearing out the cases of genuine borrowers who are having a difficulty repaying their loans. To some of these borrowers, an OTS may also be offered as a solution, the media reports.

While this may seem like manna from heaven for such borrowers wilting under a debt pile, it can have quite a damaging effect on their CIBIL score. Let's see how.

What a bank does

If a borrower has turned delinquent for a time frame of six months or more, a bank is likely to offer an OTS if the case is genuine. It may consider things such as a job loss, an accident or a serious medical condition.

The bank then sits across the table with the borrower, takes stock of his situation and agrees to 'write off' the difference between the amount that has been paid and the amount that is due.

In effect, it reports a loss, and the borrower is let off the hook. While the borrower may heave a sigh of relief, because recovery agents won't come after her/him, s/he may not be aware of the fact that s/he pays a heavy price for it elsewhere.

The impact on the CIBIL score

When a bank writes off a loan, it reports the same to CIBIL. While the relationship between the lender and borrower may have been terminated, CIBIL does not record this transaction as a 'closure' of the loan account and instead records it as 'settled'.

This is then considered negative credit behaviour and your CIBIL score can drop by as much as 75-100 points as a result of a 'settled' loan.

What is even worse than this is a record that will remain in your CIBIL report for as many as seven years. This means that if you need to avail of a loan facility anytime in the seven years after one loan account has been settled, it is likely that prospective lenders will be wary of lending to you.

It is highly likely that banks will reject your loan application when it pulls out your CIBIL report, to judge your credit worthiness, because of this one blotch on your CIBIL report.

Lack of awareness

Usually people who are bogged down by debt, grab the opportunity of an OTS, but in most cases they are unaware that a pound of flesh is being taken elsewhere. As we explained, a settled account will do more damage to your credit history than you can imagine!

The other way out

If you are struggling with the repayment of your debt and do not know what to do, do not jump at the first opportunity of a settlement. Instead, see if you can liquidate a part of your portfolio or some other assets to repay your loan.

If that does not work out, reach out to your family and friends for some help. What we are essentially trying to say is that avoid 'settlement' by all means!

It is not an easy way out, if you thought so.

That having said, the vagaries of life are difficult to predict, and if all doors are closed you may perhaps have to agree to a settlement.

However, do use this as the very last option and try and negotiate with your bank on easier payment terms, such as the extension of the repayment tenure or a waiver of the interest component, at least for some time.

Be clear on where you stand

Whatever your decision may be, make sure you check your CIBIL score and your CIBIL report after you reach an agreement with your lender, to see where you stand. Once you know what your CIBIL score is, concentrate all your efforts in repaying all other loans and maintaining impeccable credit behaviour.

While this will not exonerate you completely, it will bring up your CIBIL score gradually over a period of 12-24 months.

So, as you can see, a loan settlement is not the best option for a borrower.

Whenever you take a loan, make sure you have a contingency plan or some emergency funds that can meet your repayment commitments and you do not have to opt for a settlement that can damage your CIBIL score.

Illustration: Uttam Ghosh/Rediff.com

The author is a credit expert with 10 years of experience in personal finance and consumer banking industry and another 7 years in credit bureau sector. Rajiv was instrumental in setting up India's first credit bureau, Credit Information Bureau (India) Limited (CIBIL). He has also worked with Citibank, Canara Bank, HDFC Bank, IDBI Bank and Experian in various capacities.