How To Improve Your Credit Score After Loan Settlement?

When a financial emergency strikes, your entire budget goes for a toss. You will have difficulty managing your household expenses, paying for your child's education, and, most importantly, repaying your debts. When the situation worsens, you may look for a one-time settlement and expect your lender to provide some kind of relief from various charges. But is this a wise decision? To begin, let's understand the concept of loan settlement in depth and then look at how to fix your credit score.
 

What is loan settlement?

 
Many borrowers mix up the terms loan closure and loan settlement. They believe both are similar, but this is not the case. A loan settlement is where you choose to close your account by paying a lower amount than what you agreed upon. Under this, the lender either waives the unpaid interest component or, in the worst-case scenario, closes your loan for an amount less than the outstanding balance.
 
On the other hand, loan closure refers to a situation in which you repay your dues by the binding due date without requesting any changes to the loan terms.
 
Opting for a loan settlement comes with various negative repercussions. The most common ones are a drop in credit score and limiting your future borrowing capacity. 

What effect does a loan settlement have on your credit report?

When you choose a loan settlement, your lender suffers a significant financial loss. This loss is primarily in terms of interest income. In some cases, the lenders fail to recover even the principal amount. When this happens, they record the waived-off amount as a loss in their books and notify the credit bureaus.
 
The credit bureaus then lower your credit score and highlight the settlement on your credit report, after evaluating the extent of loss, along with a few other parameters. Such negative information will remain on your credit report for at least seven years, making it extremely difficult for you to obtain any type of loan, particularly an unsecured loan such as a personal loan, during this time. Furthermore, the financial institution with which you settled a loan may blacklist you for life and refuse to accept any future applications or transactions from you.
 

Is it possible to get a loan after settlement?

 
If you are unable to repay your debt on time due to financial problems, you may ask your lender to close your loan account rather than settle it. If the unpaid dues are less, you may negotiate with your lender on a delayed penalty, outstanding interest component, etc. You may further request them to provide you with a chargeback facility. Under this, the disputed default transactions, such as late payments, can be temporarily reversed. 
 
Also, ensure you have received a no dues certificate from your lender. The certificate states that you have no outstanding balances with that particular lender. It will also be used as evidence when disputing error reports on your credit report.
 
Also Read: Can A Personal Loan Help You Improve Your Credit Score?
 

How to improve credit score after loan settlement?

 
Obtaining funds following a loan settlement is difficult but not impossible. As previously stated, loan settlement has an impact on your creditworthiness. If you do not take the necessary steps on time, your credibility will deteriorate further. Here is what you may do to improve your credit score. 
 

1. Clear all your dues

   You may have several other loans outstanding at the time of loan settlement, but you choose to settle only one. In this case, whenever your budget allows it, or you receive a windfall of funds, pay off the other debt obligations before their binding due date.
    
   Choosing loan foreclosure sends the message to credit bureaus and lenders that your financial situation has improved over time. It also implies that you are now capable of managing your debts. As a result, credit bureaus might upgrade your credit score. 
    

2. Manage your credit cards wisely

   Credit cards are not always a good loan product. Since they have no interest rate, you can spend them extravagantly, increasing your debt burden. Furthermore, if credit card bills are not paid on time, they will incur a monthly interest penalty of around 2% on the unpaid amount.
    
   According to credit bureaus, spending more than 30% of your overall credit card limit is a sign of poor earning and inefficient budget management. Thus, it is advisable to keep track of your card utilisation and avoid unnecessary purchases on credit.
    

3. Apply for a secured loan

   Obtaining an unsecured loan with a loan settlement remark on your credit report is tough. However, if you are pledging your assets as collateral and the worth of the asset is equal to or higher than the loan value, you might easily get loan approval. 
    
   Additionally, credit bureaus consider a person with a debt portfolio that includes both secured and unsecured loans to be a disciplined borrower. Applying for a two-wheeler loan or a secured personal loan could be good options for this purpose.
    

4. Avoid multiple loan queries 

   You must accept the fact that securing funds after loan settlement is going to be tough. If a lender rejects your loan application and you immediately reapply, or if you submit your loan application to multiple lenders at once, your credit score will suffer even more. Thus, instead of being tagged as a desperate borrower, it is better to focus on things that can improve your creditworthiness. 
    

Also Read: Step By Step Guide For Checking Your Credit Score
 

To conclude
 

Loan settlement is not regarded as a prudent financial decision and causes your credit score to drop drastically. It also makes financial institutions hesitant to approve your loan application in the future. You may overcome this if you work to improve your credit score by foreclosing other existing debts, prudently managing your credit card bills, and creating a healthy debt portfolio mix of secured and unsecured loans.