Loan Settlement: Meaning, Significance in Financial Stability and Loan Settlement Process.
Loan Settlement is an agreement between the borrower and the lender where the borrower repays a portion of the debt to the lender which is usually less than the outstanding amount of the loan, as a final settlement. Loan settlement takes place in certain cases where the borrower is unable to repay the whole outstanding amount, he has borrowed due to some financial constraints like medical emergencies, job loss, or some unforeseen event.
Loan settlement contributes to your financial steadiness by reducing your burden of debt. When you settle a loan, you are eliminating a financial obligation. Oftentimes financial struggles lead to stress and fear for the borrower. This elimination would help you come out of your financial hardships by providing financial flexibility which can be used by you to reallocate your funds to other important aspects like savings, emergency funds, and investment. This will provide a sense of relief and peace of mind which will help you plan for a better life and have a financially resilient future.
We have understood what is loan settlement and its significance in achieving financial stability but how does it work? It starts with the borrower communicating to the lender about his inability to repay the loan stating the reason. After verifying the truth of the reason, the lender will offer an amount for the settlement of the loan that is less than the outstanding amount. The amount decided depends on the gravity of the situation and also on the repayment capacity of the borrower. After the borrower repays the agreed amount, the loan will be marked as “settled”(1). Depending upon the EMIs that are unpaid the lender can write off the penalty for delayed payment, processing fee, or a part of the principal amount.
UNDERSTANDING THE BURDEN OF DEBT: IMPACT ON CREDIT SCORE, INTEREST RATES AND LEGAL CONSEQUENCES
Unsettled loans create a huge impact on your life. It negatively impacts your credit score. A credit score(2) is a three-digit number that reflects your creditworthiness. It is calculated taking into consideration your credit repayment history among other factors. The higher the credit score the better chances of getting loans. It also helps the lenders assess your likelihood of repayment of the loan. However, a loan settlement in your credit history will critically diminish your credit score which will cause problems in receiving future credits. Lack of creditworthiness is reflected when the borrower pays less than the principal amount borrowed.
Oftentimes borrowers fail to take into consideration the silent threat of interest accumulation of unsettled loans. The piling up of interest rates increases the financial burden of the borrower. To ensure this doesn’t happen loan settlement can be opted which will ensure that debt doesn’t become intractable.
Having unresolved debts can cause legal consequences like legal action, wage garnishment, and confiscation of assets. The lender can take the defaulter to court, and can also report it to the credit bureaus which will tarnish the reputation of the borrower in the society and may barred him from taking future credits.
FINANCIALLY EMPOWER YOURSELF THROUGH LOAN SETTLEMENT
Opting for loan settlement can help the borrower break from the debt cycle which will help the borrower with better resource management and less debt burden. The financial burden is one of the major problems that contributes to stress, anxiety, financial insecurity, and depression. Loan settlement not only leads to improvement of the financial health and overall well-being but also positively impacts the credit score indicating the responsible financial behavior of the borrower.
EFFECTIVE LOAN SETTLEMENT: STRATEGIES, NEGOTIATION AND DEBT CONSOLIDATION
The first step towards planning for loan settlement is to carefully assess your financial situation by understanding your income level, savings, expenses, and other financial commitments that can’t be neglected. This will give you a practical overview of how much you can allocate towards the loan settlement. In case of multiple debts, prioritizing the ones that have higher interest rates and serious consequences for default will ensure a strategic approach towards the settlement process. It should be kept in mind that while planning for settlement, the amount decided on should be realistic, taking into consideration the income levels and financial capacity.
It is very important to negotiate the situation with your lender. Always show your willingness for settlement and try to build a cooperative relationship with the lender. Be transparent and honest with your lender. Depending on the genuineness of your situation the lender may be willing to waive the interest rate, extent of repayment period, penalty for delay, or processing fee. It is always desirable to have documented evidence of your financial hardships like job loss, medical bills, etc. which has resulted in your inability to repay the loan. Try to get the settlement in writing to ensure that no misunderstanding arises in the future between both parties.
As discussed above, the importance of prioritizing multiple debts according to the financial constraints and their implications, however, this can be difficult if the debts are complicated and diverse in nature. To simplify this process, borrowers can use debt consolidation. It means consolidating multiple debts into one loan. This will save time, align financial responsibilities, reduce interest rates, and ensure timely payment without default.
THE ROLE OF LOAN SETTLEMENT IN ACHIEVING 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. By 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.
CHALLENGES: HOW TO OVERCOME THEM IN LOAN SETTLEMENT
Loan settlement should not be seen as a short-term solution. It is very crucial for the borrower to focus on building a strong financial future after the loan settlement.
Often borrowers feel difficulty in negotiating with the lender, the lender may be reluctant to negotiate according to the borrower or the offer of settlement made by the lender is not favorable for the borrower. In this case, the borrower can show his cooperativeness by clearly communicating his hardships and willingness for loan settlement. Documented proof will help to pursue the lender into more favorable terms. If the borrower is unable to negotiate, he can consider seeking the assistance of reputed loan settlement companies who can negotiate on his behalf.
There is a negative impact on the credit score due to loan settlement however the borrower should focus on building good credit practices over time by repaying loans on time and having positive credit habits.
CONCLUSION
Loan settlement comes to rescue those who have no other options left. It’s a mutual agreement between the borrower and the lender where it is agreed that the borrower will pay a portion of the outstanding amount thus easing the burden of the loan. While it will have negative consequences on your credit score, it can be a crucial step towards immediate relief, breaking the cycle of debt and a new path for financial recovery. With smart financial planning, honest communication, documented evidence, cooperative negotiation, and professional help, the challenges that arise with loan settlement can be overcome. To have a lasting financial future it is important to create responsible financial habits, and investment in education, and budgeting.
Citations and references:
1. https://moneyview.in/loan-insights/loan-settlement-procedure-and-how-it-works
2. https://cleartax.in/s/loan-settlement-effects-cibil-score
This article is written by Purbasha Parui, a 1st-year law and finance enthusiast from BMS College of Law, Bangalore.
