How a ‘settled’ loan tag hurts your credit score — and ways to remove it

A ‘settled’ loan status on your credit report can unsettle your aim of borrowing funds. ‘Settled’ is not a positive thing in the world of raising money. If you have a ‘settled’ loan recorded in your credit report, then you have to change it, as it will hurt your ability to borrow.

A ‘settled’ loan is different from a ‘closed’ loan and is an arrangement with the lender wherein you pay a certain mutually agreed amount because of your inability to pay in full due to an emergency. You can change your ‘settled’ loan status to a normal one by following certain steps laid down by lenders and credit bureaus. Here is a guide on what ‘settled’ loan status in a credit report means, its impact on credit score, and steps to change it.

What does a ‘settled’ loan status in your credit report mean?

A ‘settled’ loan status in your credit report means that a loan or credit account was closed after you paid an amount that is less than the full outstanding dues. Such a status can adversely impact your creditworthiness.

There are several instances of borrowers finding it difficult to repay the loan after agreeing to pay it in EMIs (equated monthly instalments) due to genuine reasons. This may be due to job loss, sudden medical conditions, and other emergencies.

If you fail to repay the EMI for an extended period, the lender would offer you a ‘one-time settlement’. After conducting extensive discussions with you and assessing the situation, bank officials will decide the amount that needs to be settled. After you pay the mutually agreed amount, the bank will update the status of the loan account as ‘settled’ in your credit report and share the same with the credit bureau.

There is a common misperception that a ‘loan settlement’ is ‘loan closure’. A loan closure involves payment of EMIs until the last instalment as per the schedule. After all the EMIs are paid, the loan account is closed.

“Most customers mistake the term ‘loan settlement’ for ‘loan closure’. Nevertheless, both these terms are not the same. A loan closure is paying off the monthly instalments until the last payment as per the schedule; thus, closing the loan account,” ICICI Home Finance said in its explainer on ‘settled’ loans.

What is the impact of a ‘settled’ loan on credit scores?

The lender, who settles the loan with the borrower, informs the credit bureaus, such as CRIF High Mark, CIBIL, Experian, and Equifax. The loan settlement hurts the credit score as the closure of the loan or credit account is not a normal one. The term ‘settled’ reflects poorly on the borrower’s credit behaviour and as a result her/his credit score drops once the same is updated in the credit report.

“A loan settlement, unlike the loan closure, has the status marked as ‘settled’, which hurts your credit score, and it can even drop by 75-100 points,” ICICI Home Finance said.

The ‘settled’ loan status typically will stay in the credit report for up to seven years. If the borrower applies for a loan during this timeframe, the chances of availing it are quite slim, as the lender would doubt the repayment capacity. “Your past credit behaviour has a long-lasting impact. Lenders view ‘settled’ as risky, primarily because if you haven’t met your repayment obligation before, there are chances that you might do this again,” CIBIL said in an explainer on ‘settled’ loans.

Does a ‘settled’ loan affect future loan eligibility?

• A settled loan status reduces the chance of getting fresh credit. That is why credit products such as home loans, car loans, or personal loans become complicated to secure. 
• Lenders treat it as a red flag, assuming you may default again in the future. That is why you will not be seamlessly offered loans and credit cards. Even loan repayment terms will become more challenging to meet. 
• Even if approved, banks may charge you higher interest rates or stricter terms. They will focus on ensuring that the funds given to you are recovered at any cost. 
• It can also affect your chances of getting new credit cards or increasing existing credit limits. This will further hamper your overall credit profile. As ‘hard inquiries’ will result in bringing down your credit score by a few more points, in case you submit any new credit application. 
• The best way to rebuild trust is by repaying pending dues, maintaining timely payments, and gradually improving your credit score. In such a case, you should focus on maintaining a credit utilisation ratio of less than 30%.

What are the solutions available to borrowers?

Most borrowers do not know the impact of a loan settlement on their credit score. They will find it difficult to raise loans of any kind for at least seven years. If the lender proposes a settlement for your existing loan, you can request a revision in repayment terms. This includes extension of the loan tenure, reduction in interest rates, or a complete waiver of interest to enable you to pay the EMIs on time comfortably.

If you have already made a settlement and as a result your credit score is affected, you can still change it by paying the outstanding or written-off amount in your loan account. After this, you have to get a ‘No Objection Certificate (NOC)’ from the lender and inform the credit bureau about this. This will enable you to change the status of your loan account from ‘settled’ to ‘closed’.

What are the steps involved in removing a ‘settled’ loan account from your credit report?

There are instances when the credit report might show ‘settled’ even when you have never done so. In such cases, you can request the credit bureau to remove the ‘settled’ status by raising a dispute. But if your loan account is a ‘settled’ one, then here is a step-by-step guide to change the status.

1. Go to the official website of the credit bureau and log in to your account with your credentials. If you do not have an account, you can create one to request a change in loan account status or raise a dispute.
2. Select the account with ‘settled’ status and attach the supporting documents that show the updated details of the loan account, with information that you have closed the loan account with the lender.
3. Provide accurate details regarding the actual loan status and submit the request.
4. The credit bureau will then verify your claim, which may take up to 30-45 days. They will then change the status.

Though removing ‘settled’ loan status will not improve your credit score immediately, it will have a positive impact over time and will be quite helpful in availing fresh credit. Always remember that removing a ‘settled’ loan from your credit report is a must for improving your creditworthiness.

Allirajan M is a journalist with over two decades of experience. He has worked with several leading media organisations in the country and has been writing on mutual funds for nearly 16 years.

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