A personal loan allows you to get funds for all your financial needs, like medical bills, education, or home repairs. The personal loans are unsecured, which means they do not require collateral. However, if your income drops, paying your Equated Monthly Instalments (EMIs) on time becomes difficult.
When there is no other option, many borrowers choose personal loan settlement. This is when banks or Non-Banking Financial Companies (NBFCs) agree to close the loan for less than what you owe. As per CIBIL, a settled loan can reduce your credit score and stay on your report for up to 7 years. In this blog, we will understand how settlement impacts your credit score.
A personal loan settlement is a mutual decision between the borrower and lender (Banks or NBFCs), where a lender agrees to accept less than the total amount owed. After payment, the loan is marked as “settled” instead of “closed.”
This happens when you cannot repay the loan due to job loss, salary cuts, medical emergencies, or financial stress. For example, you owe a lender ₹1,50,000 but offer only ₹80,000 as a lump sum. You are settling a personal loan debtby paying the lower amount, which a lender mutually accepts. It seems helpful, but it has long-term effects. Therefore, it is necessary to understand personal loan settlement fully before agreeing.
Banks and NBFCs agree to settle a loan only when they believe the borrower cannot repay the full amount. They prefer to recover the outstanding amount rather than lose it entirely. Here are some reasons why banks and NBFCs agree:
Here are the key differences between closing a loan and settling a loan:
| Aspect | Loan Settlement | Loan Closure |
| Meaning | Part payment of the loan after negotiation. | The account is reported as “closed; it supports a healthy score. |
| Credit report status | An account reported as “settled” reduces your credit score. | The account is reported as “closed; it supports a healthy score. |
| Future borrowing | Harder to get new loans, as banks and NBFCs see settlement as high risk. | Easier to get credit, as it shows you repay fully and on time. |
| Documents | Settlement letter confirming the agreed reduced amount. | NOC or loan closure letter confirming zero outstanding balance. |
| Extra charges | You may need to pay penalties or late fees as part of the deal. | You may pay foreclosure or prepayment charges if you close early. |
Before choosing a personal loan settlement, you must know how it can damage your credit score. Many borrowers settle a loan to avoid dues fast and become debt-free, because they ignore the long-term impact on their financial profile. Here is what really happens:
1. Your Credit Score Drops by a Huge Margin
When your personal loan is tagged as “settled,” lenders see it as a sign that you could not repay in full. This raises a red flag and can reduce your credit score by a considerable margin, depending on the lender (bank and NBFC) and your profile.
2. Settlement Stays on Your Report for 7 Years
The “settled” tag stays on your credit report for up to 7 years. Every time you apply for a loan, lenders review your credit profile and history. During this time, the ‘settled’ tag can make lenders hesitant to approve a loan.
3. You May Face Challenges Getting Loans in the Future
New loan approvals become more difficult after you settle a loan. Banks and NBFCs may reject applications or offer very small amounts. They may also charge higher interest rates or offer unfavourable terms, which can increase the cost of borrowing.
4. Your bargaining power reduces
Even if a new loan is approved, your bargaining power is weak. You may get higher interest rates, strict conditions, or fewer benefits. Due to a low credit score, you cannot ask for a lower interest rate or better terms. The best solution in this situation is to improve your credit score and then apply for a loan again.
Settlement isn’t always bad; it can help in some situations. Here is when you should opt for a personal loan settlement:
In such cases, settlement can reduce your burden and give you some breathing space. You must still understand the long-term impact of personal loan settlementon your credit score before finalising it.
Instead of settling your personal loan, you can opt for these alternatives to protect your credit score:
A personal loan helps you access necessary funds in difficult times, but repayment can become difficult when life emergencies and uncertainties occur. In such situations, options for a personal loan settlement might appear convenient.
While you may not always have to control your emergencies, you can always choose a lending partner that not only offers financial support with a loan but also makes repayment easier. DMI Finance achieves just that with competitive interest rates and flexible repayment options. Apply for a personal loan now and get up to ₹10 lakh with flexible tenures up to 48 months.
1. Can I negotiate a settlement even if my loan is not yet in default?
Yes, you can negotiate a settlement even before missing any EMIs. Banks or NBFCs usually consider settlement only after long delays or serious hardship.
2. Does a settlement affect my co-borrower or guarantor?
Yes, the settled status appears in their credit reports and can impact their ability to access loans in the future. It typically remains on the report for up to 7 years.
3. Will collection calls stop immediately after settlement?
They stop only after the banks or NBFCs update your account. Keep proof of payment until the update is reflected.
4. Can I ask the banks or NBFCs to remove the “settled” tag later?
No. While the lender cannot change your credit history, credit bureaus do have the authority to update or correct the record if needed.
5. Is it possible to convert a settlement into a closure by paying the remaining amount later?
Yes, paying the waived amount later can change the status to “closed,” but not all banks or NBFCs allow this.
6. Can I settle a loan using EMI instead of a one-time payment?
Usually, no; settlement is typically accepted only as a lump-sum payment.
7. Does settlement stop banks or NBFCs from taking legal action?
Yes, once you sign and complete a valid settlement agreement, legal action usually ends.
8. Do I need a lawyer for personal loan settlement?
Not always, but a lawyer can help if the banks or NBFCs are threatening legal action or if the terms are unclear.
9. Will the settlement impact my ability to become a co-signer for someone else’s loan?
Yes, banks or NBFCs may reject your co-signer request if they see a settled loan in your history.
10. Can banks or NBFCs refuse to give me a settlement letter after payment?
Yes, they must provide it. Always insist on a settlement letter as official proof.
| Personal Loan of Different Amounts | ||
| ₹50,000 Personal Loan | ₹1 lakh Personal Loan | ₹2 lakh Personal Loan |
| ₹3 lakh Personal Loan | ₹4 lakh Personal Loan | ₹5 lakh Personal Loan |
