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


If you are unable to repay your loan for 91 consecutive days, your lender will classify the loan as non-performing asset (NPA). You might be unable to repay your debts due to various reasons such as loss of income, financial emergency, a dispute over payment terms with the lender or perhaps due to mismanagement of your money. After pursuing you for several months for repayments, your bank offers you the option of settling in one go: make a partial payment in one go of your contribution, and consider the loan paid off. But should we take this option?

The OTS, as banks call it, is one of the few options a defaulter has to repay their dues and get out of debt. Typically, the OTS offer requires the defaulter to pay their principal in full. Interest due as well as penalties and other charges may be partially or totally canceled. In some cases, part of the capital can also be canceled. In total, the defaulter can repay a fraction of the total amount of contributions and consider the loan “settled”. However, when you repay your loan in full with interest and related fees, the loan is considered “closed”. There is a big difference between “closing” and “paying” your loan.

The banking industry has a long history of dealing with NPAs. This year, the Reserve Bank of India mandated banks to develop a 30-day recovery plan for a defaulted account. Banks will have an additional 180 days to implement their plan. With their booming NPAs, banks will do their best to recover stressed assets. One of these options can be OTS. Banks can offer a defaulter the option of paying part of their contributions, while writing off the rest as a loss. This way the loan is settled and the defaulter will not be tracked down by the collection agencies. However, there is more to a settlement than simply terminating a loan account.

The advantage – if we can say it all like this – is that the borrower, who is no longer able to repay his debts, can take the OTS option to clear his contributions on terms that suit him as well as at the bank. Once this option is exercised, the loan account is terminated and the bank cancels the unpaid contributions. But also consider the damaging consequences of a settlement.

A settled loan does not mean the end of a borrower’s problems. First, the bank will report the status of the loan as “settled” to credit bureaus such as Experian and CIBIL. It would ruin the borrower’s credit rating – by a margin of 50 to 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 say that a loan was paid off, which basically means he didn’t have the income to pay off his debts. His credit report will mention it for the next seven years. During this period, it would make it almost impossible for him to borrow again and he will also be blacklisted by his bank.

Debt collectors may not adequately help borrowers understand where the settlement leads. And so, in times of financial crisis, paying off your loan may seem like a viable option. But this is not the case, and the consequences of a settlement are serious. As a blacklisted borrower, it will be difficult for you to borrow again, which will hamper several life goals such as buying a house or car, or obtaining a mortgage. student loan to further your career. You may not be able to borrow to start a business or in an emergency such as a health problem. You won’t have a credit card. The punishment for settling, therefore, is for not being able to fulfill the aspirations of your life.

In debt, your goal should always be to repay your membership fee in full. If the default was caused by a disputed debit, report it to the bank and work to resolve it. If the default is due to your inability to pay your dues, assess the banks for your problems. Ask for time and look for a restructuring of your debts that will facilitate repayment. If you run out of money, take out an interest-free loan from family or friends. At the same time, work on developing income that can make it easier for you to manage your debts.

Let’s say there is no financial way 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 at a later date. Once you have the financial means, contact your bank and offer to reimburse your contributions in full (principal, interest, penalties and other fees). After full refund, collect your non-contribution certificate from the bank. The bank will report your account as closed to the credit bureaus. Alternatively, you can also report the development to the offices and file a request for a change of status to closed.

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