In credit reports, settlement and closing are different

A fragile financial situation can lead the borrower to default on many of the monthly equivalent payments (EMI) of his loan. Whenever there is a default, banks attempt to recover the bad loan either through settlement or closing.

Difference Between Settlement and Closing

Let’s take an example. Suppose you were unable to pay your EMI car loan even after a grace period of 90 days and the total amount due is 3 lakh. This amount of the loan will be considered as a default, and the bank will transfer your file to a debt collection agency, which it will have mandated. The agency will contact you to recover the contribution. The debt collector’s goal is to get you to pay as much of the outstanding amount as possible, especially since he receives a commission based on that amount. After meeting the debt collector, you manage to pay 2.5 lakh of the 3 lakh owed. If the debt collector decides to forfeit the remainder of the loan, this is called a settlement.

You may think you paid what you could and the case is closed, but you would be wrong. Since you haven’t repaid all of the debt and still owe the bank 50,000, this will go on the bank’s books as a permanent default.

Alternatively, if you had paid the debt collector the full loan amount of 3 lakh, the bank would have considered it a closing.

Why is this important?

Your credit history plays an important role when applying for credit. For example, when approaching a bank for a credit card, the chances of your application being rejected are higher if you do not have a clean credit history, which may be the result of a settlement or an earlier closure. When you default on a loan, even a credit card payment, your credit score is affected. And until you improve your credit score, pay off all arrears, and resolve other issues, banks are likely to refuse additional credit.

Remember that both settlement and closing affect your credit score and your overall ability to obtain credit. But the level of impact varies. A settlement causes a bigger dent in your credit score than a closing.

Banks will be more likely to lend to someone who has settled their debt by paying a lesser amount. Such a person may take longer to improve their credit rating. In addition, some banks may even reject his request for additional credit. If the borrower had closed his debt, that is, repaid the entire amount to the debt collector, it would be easier for him to improve his credit rating. And banks will be more willing to lend to someone who has paid off all of their debt.

Therefore, if you have defaulted on a loan, be sure to repay the full amount owed. Otherwise, you may have to bear the consequences later.

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