Money talk: Why you should aim to close a loan, not settle it

If you are unable to service your loan for 91 straight days, your lender will classify the loan as a Non Performing Asset (NPA). You may be unable to repay your debts for various reasons such as loss of income, a financial emergency, a dispute over the payment terms with the lender, or perhaps due to poor money management. Having chased you for repayments for several months, your bank gives you the one-time settlement option: make a one-time part payment of your dues, and consider the loan settled. But, should you take this option?

INTRODUCTION TO ONE-TIME SETTLEMENT
OTS, as the banks call it, is one of the handful of options a defaulter has to repay his dues and get out of debt. Typically, the OTS offer requires the defaulter to pay his principal amount due in full. The interest due along with penalties and other charges may be partly or wholly waived off. In some cases, a portion of the principal may be waived off as well. In totality, the defaulter may pay off a fraction of the total dues and consider the loan “settled”. However, when you pay your loan with its interest and attendant charges in full, the loan is considered “closed”. There is a big difference between “closing” and “settling” your loan.

WHY LENDERS OFFER YOU OTS
The banking industry has been for long dealing with NPAs. This year, the Reserve Bank of India has mandated banks to come up with a recovery plan in 30 days for an account in default. The banks will get a further 180 days to implement their plan. With their burgeoning NPAs, banks will try their best to recover stressed assets. One of these options can be the OTS. The banks may offer a defaulter the option to pay part of his dues, while writing off the rest as a loss. This way, the loan is settled, and the defaulter will not be hounded by recovery agencies. However, there is much more to a settlement than the mere termination of a loan account.

THE BENEFITS FOR BORROWERS
The benefit — if it all it can be called that — is that the borrower, who is no longer in position to repay his debts, can take the OTS option to clear his dues at terms agreeable to him as well as the bank. Once this option has been exercised, the loan account is terminated and the bank writing off the dues that weren’t settled. But also consider the damaging consequences of a settlement.

THE DAMAGING IMPACT
A settled loan doesn’t mean the end of a borrower's problems. First of all, the bank will report the loan status as “settled” to credit bureaus such as Experian and CIBIL. This would wreck the borrower’s credit score — by a margin of 50-100 points or more. If he has settled multiple credit accounts, the impact will be magnified. The account status section in his credit report would reflect that a loan was settled, which essentially means that he didn’t have the income to repay his debts. His credit report will mention this for the next seven years. During this period, it would make any new borrowings next to impossible for him, and he will also be blacklisted by his bank.

THE LONG TERM DAMAGE
Recovery agents may not adequately help borrowers understand what the settlement leads to. And hence, in a financial crunch, settling one’s loan may seem like a viable option. But it isn’t, and a consequences of a settlement are severe. As a blacklisted borrower, you will find it difficult to borrow again, and this will impede several life goals such as buying a home or car, or taking an education loan to further your career. You may not be able to borrow to set up a business, or during an emergency such as a health problem. You won’t get a credit card. The punishment for settlement is, therefore, not being able to fulfil your life’s aspirations.

WHAT YOU SHOULD DO
In debt, your goal should always be to repay your dues in full. If the default has been caused by a disputed charge, report it to the bank and work towards resolution. If the default is due to your inability to pay your dues, appraise the banks of your problems. Ask for time and seek a restructuring of your debts which will make repayment easier. If you’re out of money, take an interest-free loan from family or friends. Simultan-eously, work on developing income that may make it easier for you to manage your debts.

BUT IF YOU CAN’T AVOID A SETTLEMENT
Let’s say that there is no financial means for you to avoid a settlement, so you take the option. However, you still have the option of converting a settled account to a closed account later. Once you have the financial means, reach back to your bank and offer to repay your dues — principal, interest, penalties and other charges — in full. After the full repayment, collect your no-dues certificate from the bank. The bank will report your account as closed to credit bureaus. Alternatively, you could also report the development to the bureaus and put in a request for a change of status to closed.