It is that time of the year when you find neighbourhood markets, malls and e-commerce websites full of offers and deals across products. Even banks and financial institutions are offering easy and instant financing schemes with zero processing fees and low interest rates. Before you get swept in by the festive euphoria and end up taking credit, remember that taking too much debt through unsecured loans can create problems for you if you are unable to pay up on time.

To start with, the interest outgo on any credit card debt or unsecured loan will increase substantially if you delay the payments of bills or EMIs. Remember that in such situations, part payment or one-time loan settlement deals are not the answer either. Non-payment or even part payment or one-time settlement will also hit your credit score, affecting your loan taking capacity in the future. We tell you how this pans out and what a poor credit score means for you.

Impact on credit score

Loans and credit score share a positive correlation: the higher the credit score, the higher chances you have to avail a loan and negotiate the interest rate on that loan. A good credit score also enhances your loan amount eligibility.

Graphic: Santosh Sharma/Mint
Graphic: Santosh Sharma/Mint

Remember that your credit score is directly dependent on your repayment history: delay or default in paying of dues may impact your credit core negatively. Poor credit score can also lead to closure of a fresh line of credit.

In cases of delay or default, especially on unsecured loans, lending institutions often offer borrowers the option to make part payment or go for a one-time loan settlement. Part-payment is generally offered when borrowers default on a few EMIs because of temporary or short-term financial stress and promise to pay future EMIs regularly, while one-time loan settlement is offered to borrowers in severe financial distress.

“Banks generally offer the option of one-time loan settlements to those who face financial difficulties for various reasons such as loss of income and employment, health problems, or losses in business," said Adhil Shetty, chief executive officer, BankBazaar, a financial marketplace. Loan settlements are also done in cases where there’s a dispute between lenders and borrowers. This option is offered to you only after you have gone three straight months without paying your EMIs, and if the lender feels there is a good reason for you to default on your payments, added Shetty.

Typically, lending institutions waive off some amount of interest and late fees and ask borrowers to clear the remaining dues. Their main aim is to at least recover the principal amount. Most banks have schemes to deal with non-performing assets and these settlements fall under such schemes. Typically, the final amount to be paid for settlement depends on the negotiation between the lender and the borrower.

When banks or recovery agents make such offers, you may feel that it is wise to accept the bank’s offer. However, this can have a bearing on your credit score.

Banks and financial institutions report or share details of borrowings and repayments made by borrowers with credit rating companies. The credit score is developed on the basis of such information. When you opt for loan settlement, “after completion of paper work your lender will report the settlement to the credit bureaus. Following this, your account status will show as ‘settled’ and not ‘closed’. This essentially means that you have only partly repaid your loan," said Shetty.

Most credit bureaus provide a credit score ranging from 300 to 900 and lenders prefer those with a score of at least 750. “One-time settlements sound like a beneficial option, especially for the near future, but they can significantly impact your credit score," said Shetty.

However, your credit score starts getting dented way before you go for loan settlement. “Credit score start getting impacted from the very first month in which the borrower delays the payment of an EMI," said Ashish Singhal, managing director, Experian Credit Information Co., a credit bureau.

Settling a loan

Sometimes you don’t have an option apart from settling a loan. If you find yourself in such a situation, make sure you don’t fall for fraudulent practices. “Make sure that final settlement offer comes from the lender rather than an intermediary of the lender," said Singhal.

A lot of lenders have collection agents, who have big targets to achieve and their incentives or pay cheques are linked to the number and volume of collection. In many cases, to achieve their targets, these collection agents or intermediaries offer a small fraction of the outstanding loan as the settlement amount. In truth, they pay this money towards the EMI, because the target for recovery agents is to recover EMI payments. Here, the loan doesn’t get settled in the books of the bank, and the following month, the bank will still get in touch with you for the next EMI.

Therefore, while considering a loan settlement offer, insist on a written offer on the bank’s letter head or an email from the bank’s official address.

Also, make sure you make payment in the loan account of the lender and get an acknowledgement, stating that this loan has been settled fully in their books of accounts with the money you have paid as part of the loan settlement offer, added Singhal.

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