If you are struggling to pay your loan repayments, one option you might consider is term loan settlement. Banks and financial institutions sometimes offer borrowers the option to settle their loans by paying a lump sum amount, usually lower than the outstanding dues.
This may sound like a relief, but this arrangement has legal implications and financial consequences that you need to understand. So, is loan settlement legal in India? The snapshot answer to that question is yes. But it is not an easy-to-do process.
The Reserve Banik of India guidelines govern loan settlements, and banks follow specific procedures before agreeing to the settlement.
If the loan settlement is the only way out for you then understand the entire process of loan settlement in India so that you know the loan term impact on your financial health.
In this article, we will discuss the legality of the loan settlement in India, with pros and cons, and whether it’s the right choice for you, so, let’s dive in!
Understanding Loan Settlement in India
A loan settlement is reported as Settled in your credit history instead of “Closed” which is flagged as a red flag by the lender which makes your future securing of the loan problematic.
This can remain like this for years affecting your creditworthiness for years, that’s why loan settlement should be something that you should use as a last resort. Before considering it, you should explore alternatives like loan restructuring, balance transfers, or negotiating lower EMIs.
But if it has come to this, then you should also know how the entire loan settlement process happens, which is explained in detail below.
What is Loan Settlement?
A Loan settlement can be understood as a negotiated agreement that you make with the lender as a borrower. In this agreement, you agree to pay a lump sum amount usually less than the total outstanding amount. The Bank marks the loan as “settled” instead of “closed” in your credit history.
How Does Loan Settlement Work?
The following is the step-by-step process that Loan settlement works:
- When borrowers fail to make regular loan repayments, the lender declares the loan as a Non-Performing Asset (NPA).
- After this, the lender offers a settlement amount lower than the total due for which you have to negotiate and pay an agreed amount, and the bank writes off the rest.
- The loan status is marked as “settled” in credit records, affecting credit scores.
Is Loan Settlement Legal in India?
Yes, loan settlement is legal in India. The Reserve Bank of India (RBI) has set guidelines that direct lenders to conduct the loan settlement process. However, it is not the borrower’s or lender’s right to decide whether to offer you a loan settlement. Banks are not obligated to settle a loan and they can prefer loan recovery over settlement.
RBI Guidelines on Loan Settlements
RBI provides clear rules on how banks should handle bad debts recovery and settlements, some of the key procedures include:
- Banks have to engage in fair practices to recover the loan amount and negotiate a settlement.
- Settlement is different than loan waiver and the borrower would still owe money to the bank but with a reduced amount.
- Loan settlements will impact credit scores negatively and borrowers would not have any say in this.
- Banks should try restructuring over settling a loan.
Loan Settlement vs Loan Waiver: Key Differences
RBI says banks should prefer loan waivers over loan settlements. It is also important for you to understand the difference between loan settlement and loan waiver. Here are the key differences between Loan Settlement and Loan Waiver-
| Factor | Loan Settlement | Loan Waiver |
| Definition | Loan settlement is a process where the borrower negotiates with the lender to pay a reduced amount as a one-time payment for closing the loan account. | A loan waiver is when the lender forgives the borrower’s outstanding loan amount, meaning they are not required to repay it. |
| Offered By | Banks and NBFCs | Government & Banks |
| Payment Required | Yes (Lump Sum) | No Payment Required |
| Credit Score Impact | Negative (Settled Status) | No Impact |
| Who Benefits? | Individual Borrowers | Farmers, Small Businesses, Special Cases |
Pros and Cons of Loan Settlement
The following are the pros and cons of loan settlement:
Benefits of Loan Settlement
- The benefit of loan settlement is to provide immediate relief to reduce the debt burden.
- It helps the borrowers to prevent any lawsuits and unpleasant encounters with recovery agents.
- Allows you to be financially sound reducing your stress.
Disadvantages and Risks
- When you go through the loan settlement, the displayed status on your credit reports is loan settled instead of closed which will damage your credit score.
- The Bank would hesitate to lend when they see settled status.
- Lenders may refuse your loan settlement request.
How does Loan Settlement Affect Your CIBIL Score?
The loan settlement status on your credit report is not the full repayments which may be problematic for the credit score. Here are some of the effects that your CIBIL Score would have if you go through the Loan Settlement-
- Your CIBIL report is made as “settled” instead of “closed” which is viewed as a red flag.
- It reduces your creditworthiness making any future loan approvals difficult.
- It remains in your CIBIL history for more than 7 years.
- There is a better alternatives and you should try to repay your loan in full or explore restructuring before opting for settlement.
Alternative Options to Loan Settlement
Now that you know how loan settlement works you should also know what alternative option you have. Here are some of the alternatives for loan settlement:
Loan Restructuring
Loan Restructuring is a process where the lender would restructure the loan terms to make it easier for the borrower to repay the loan.
Debt Consolidation
Debt Consolidation is when you combine multiple loans into a single loan usually with a lower interest rate or better repayment terms.
Negotiating Lower EMIs
You can negotiate lower EMIs with the lender to ensure it becomes easy for you to repay the payment.
FAQ
Does loan settlement mean my loan is completely forgiven?
No loan settlement does not mean the loan is forgiven. The lender agrees to accept a reduced amount but the remaining amount is not written off and it affects your credit history.
How does loan settlement impact my CIBIL score?
Loan Settlement is reported as Settled in your Credit Report and this status remains in the report for more than 7 years. This lowers your credit score and makes it harder for you to secure any future loan.
Do banks always agree to loan settlements?
No, it is up to the bank to get a loan settlement. You have to negotiate with the bank and only in the extreme cases where the borrower is financially incapable of repaying the loan would make the bank go for loan settlement.
Can I get a loan after a loan settlement?
Yes, but it will be difficult and the interest rate will be very high. You have to understand that the settled status on your credit report shows that lending money to you would be riskier for them.
Is loan settlement a legal process?
Yes, loan settlement is a legal process and RBI has proper guidelines to conduct a loan settlement process.
How long does a loan settlement affect my credit score?
A loan settlement status would be displayed on your credit report for up to 7 years which affects your ability to get loans in the future.