This ‘settlement’ is bad for financial health

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Millions of people take loans to meet financial needs. Many times, situations like job loss, business downturn, or sudden illness arise. In such a situation, the person who takes the loan is unable to meet the conditions of repaying it. On top of that, the interest and penalties keep increasing.  A person gets trapped in the web of debt. That’s when the banks offer a one-time settlement or OTS option. Recently, the Ministry of Finance has directed public sector banks to reach a one-time settlement with defaulters. These  loans should range from Rs 20 lakh to Rs 1 crore. Through mutual agreement, the matter can be settled. But is it wise to go for OTS? Let’s find out.

What is a OTS When a person fails to pay the equated monthly installment or or any  of a loan for more than 90 days. Then, the bank or financial institution inquires about the reason for not repaying the EMI.  Banks or finance companies scrutinize the person’s claims carefully. If reasons are genuine.  Borrower is offered a loan settlement option.

In case of one-time loan settlement, the bank tries to settle the account by accepting payment of at least the principal amount in a single go. In such a situation, the bank waives off the interest amount, penalties, or legal expenses. Settlement amount is decided after taking into consideration the debtor’s repayment capacity. After payment of  settlement amount, the bank closes the loan by writing off the difference between the total outstanding amount and the settlement amount.

For example, if a borrower had taken a loan of 10 lakh rupees. Currently, the total outstanding on his loan is 7,00,000 rupees. Adding the interest, penalties, and legal expenses, it amounts to a total of 7,50,000 rupees. The lender can offer Mohit a one-time settlement by depositing 5,00,000 rupees and close the loan.  The remaining 250,000 rupees will be waived off. It will be shown as a loss in the account statement.

Negative impact You may find it good news that you only have to pay 5,00,000 rupees instead of 7,50,000 rupees, but there will be long-term negative consequences. In fact, by closing the loan in this manner, the status of the loan account will change from “Closed” to “Settled”.  Status of a loan account shows as “Closed” when the loan is closed after timely repayment. This information will be sent to credit rating agencies by financial institutions. A settled account is not considered as a regular closed account, so it has a negative impact on your credit score.  This will make it difficult for you to obtain loans or credit cards for several years. Banks may refuse to lend to you or you will get loans at higher interest rate.

Other options One-time loan settlement should be the last option. Apart from that, there are other ways through which you can get out of debt trap. If you have any savings or investments, utilise it to repay the entire debt. Try to borrow interest-free loans from relatives or friends to pay off the outstanding balance to the bank. Speak to the bank for loan restructuring so that you can easily repay the full amount. Instead of opting for a one-time settlement with the bank, ask for some more time so that you can repay the loan.

Banks or finance companies do not offer one-time settlements in every case. Moreover, in the future, it will be difficult to get a loan when you need it.  Make an effort to close the loan instead of settling it.