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INTRODUCTION

Loan settlement is an agreement between the borrower and the lender, where the former pays a portion of the amount that is outstanding to the lender as final settlement. Laon settlement usually happens when the borrower is unable to repay the loan due to some financial hardships such as medical emergencies, job loss, or some unexpected expenses. Depending on the genuineness of the reason, the lender will decrease the amount that the borrower has to repay.

BENEFITS OF LOAN SETTLEMENT

Let’s see some of the benefits that you can get out of loan settlement.

  • HELPS TO GET INSTANT RELIEF

During times of financial crisis, the inability to repay the loan puts a lot of stress and anxiety on the shoulders of the borrower. However, opting for loan settlement will help the borrower by not only paying less amount but also providing instant relief.

  • HELPS TO AVOID DEFAULT

 You may face serious consequences when you default on the loan. Your assets can be confiscated, a negative effect on your credit score and legal actions can be initiated against you. But if you sign a loan settlement with your lender you can avoid this situation.

  • HELPS TO ACHIEVE YOUR FINANCIAL GOALS

Settlement of a loan provides instant financial relief when you are struggling to make regular payments. It will help the borrower to overcome his financial crisis and have a new start where he can plan for investment and savings. Even though the settlement of a loan undermines your creditworthiness, as a last resort when you have exhausted all of your resources and options, resorting to loan settlement will show responsible financial behavior which can positively influence your future credit requirements. Loan settlement is one of the tools to build a strong financial foundation. It can be used to reduce debt but also it should be used wisely and complement other financial practices. Making a budget, outlining the monthly expenses and income, cutting down unnecessary costs, and creating an emergency fund will provide you with a strong financial base and also prevent you from taking more loans during the time of financial crisis which will increase the overall burden of debt on you.

 DRAWBACKS OF LOAN SETTLEMENT

loan settlement can help the borrower out of his financial crisis but it comes with a lot of negative consequences. Firstly, it negatively impacts your credit score. When you pay less than the amount borrower it shows a lack of creditworthiness. After the settlement process, the lender reports it to the credit bureau, and the loan is marked as “settled” rather than “closed”. This significantly brings down the credit score of the borrower.

As most personal loans are unsecured, it means that the lenders assess the risk involved and the repaying capacity of the borrower through the credit score. The higher the credit score the better chances of getting approved for loans with better terms and lower interest rates.

But if the credit score is less the borrower will face difficulties in getting loans in the future. Loan settlement also harms in the long run by limiting the financial opportunities in the future.

 WHAT OTHER OPTIONS YOU HAVE?

Loan settlement can hurt your credit score. So, before option for it, it’s crucial to explore the different types of alternatives that are there. Some of the alternatives that you can consider are:

  • Debt consolidation

Debt consolidation is something that often comes into view while managing debts. It is a process in which multiple debts are paid off by consolidating all your debts into one single debt. It helps by streamlining your income and also reducing your monthly payments and lowering interest rates. It can be helpful when you are facing difficulties with managing and repaying multiple loans.

  •  Credit counseling

Credit counselors help you by advising you on managing your income and debts, developing a budget, educating you on your situation to build better financial habits, and making a debt management plan to pay your debts.

  •  Negotiating lower interest rates

During a financial crisis, paying interest rates adds up to the already existing burden. However, you can communicate with your lenders and negotiate to bring down the interest rate.

  •  Asset liquidation

Asset liquidation means converting your assets into cash. This can help you to repay your debts with the cash.

  •  Pledging assets

You can also pledge your assets such as a savings account as collateral for the loan. It helps to reduce the down payment and also reduces the interest rate.

 IS LOAN SETTLEMENT A BETTER OPTION?

Loan settlement may seem like an easy way out when you are not able to repay your debt. It’s a tempting option because of the reduced payment. However, it is advised not to go for loan settlement. It severely damages your credit score which affects your future borrowing prospects. It’s better to first exhaust the alternative options that you may have such as debt consolidation, asset liquidation, credit counseling, etc. before opting for loan settlement. It’s crucial to calculate all the risks and consequences that you may face before opting for loan settlement.

CONCLUSION

Loan settlement is a process where the lender accepts an amount from the borrower that is less than the outstanding amount as the final settlement. It provides instant relief from debt, by avoiding defaulting on debt and helps to achieve your financial goals. However, it comes with its drawbacks because it negatively affects your credit score and it is not advisable to opt for loan settlement unless you have exhausted other available options such as asset liquidation, debt consolidation, etc. But as a last resort, it can greatly help you to come out of your financial crisis.

This article is written by Purbasha Parui, a 1st-year law and finance enthusiast from BMS College of Law, Bangalore.

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