Managing loan repayments can be challenging, especially when facing financial difficulties. In such cases, borrowers are often presented with two options: loan settlement and loan restructure. Each option has its pros and cons, and choosing the right one can have significant implications for your financial future. Understanding when to opt for loan settlement and when to consider loan restructuring is key to making a sound financial decision. This article outlines the differences between the two options, their impacts, and when each is appropriate.
What is loan settlement?
Loan settlement is an option offered by lenders when a borrower is unable to repay the full loan amount. In a loan settlement, the lender agrees to accept a lower amount than the total outstanding balance to close the loan. This option is often considered a last resort when the borrower is facing severe financial hardship. The loan is marked as “settled” on the borrower’s credit report, which negatively affects their credit score.
Key considerations for loan settlement
- Credit score impact: Loan settlement negatively impacts your credit score, as the loan is not fully repaid. Instead of being marked as “paid in full,” the loan is recorded as “settled,” which signifies that the lender had to settle for a lower payment.
- Limited future borrowing: A settled loan on your credit history makes it difficult to secure future loans, as lenders may perceive you as a higher risk.
- Debt relief: Loan settlement can provide immediate relief by significantly reducing your overall debt, which is ideal if you are in financial distress and cannot afford full repayment.
What is loan restructure?
Loan restructure, on the other hand, involves renegotiating the terms of the loan to make repayment more manageable. Rather than reducing the total amount owed, loan restructuring may extend the loan tenure, reduce the interest rate, or adjust the repayment schedule. The key benefit of restructuring is that you continue to repay the loan in full but with modified terms that better suit your current financial situation.
Key considerations for loan restructure
- Minimal credit impact: Compared to loan settlement, loan restructuring has a far less severe impact on your credit score. Since you continue repaying the loan under revised terms, lenders see this as a positive move toward fulfilling your debt obligations.
- Extended repayment period: Loan restructuring often involves extending the tenure of the loan, which results in smaller monthly payments. However, this may also lead to paying more in total interest over the extended period.
- Loan remains active: Unlike settlement, loan restructuring keeps your loan active, allowing you to manage your repayment without closing the account or significantly affecting your credit score.
Loan settlement vs loan restructure: key differences
| Aspect | Loan settlement | Loan restructure |
| Objective | Reduce the outstanding debt | Modify the loan terms to make repayment manageable |
| Credit score impact | Negative (loan marked as “settled”) | Minimal impact (loan remains active with new terms) |
| Loan status | Loan is closed after settlement | Loan remains active with modified terms |
| Future borrowing | Difficult to secure new loans | Easier to secure future loans |
| Debt amount | Reduced to a lower agreed amount | Full amount still owed |
| EMI payments | Payments stop after settlement | Payments continue under revised terms |
When to choose loan settlement
1. Severe financial distress
If you are facing extreme financial hardship, such as job loss or medical emergencies, and are unable to continue making regular payments, loan settlement might be a viable option. In such cases, settlement helps reduce the debt burden and offers a way out when repayment is no longer feasible.
2. No plans for future borrowing
Since loan settlement significantly lowers your credit score, it is best suited for individuals who do not plan to apply for loans in the near future. If your main goal is to reduce your current debt load, and you do not need future credit, settlement may be the right choice.
3. Significant debt reduction
In some cases, borrowers can negotiate with the lender to reduce the debt substantially. If the lender agrees to a large reduction in the outstanding balance, loan settlement may be a good option. However, be prepared for the impact on your credit score.
When to choose loan restructure
1. Temporary cash flow issues
If your financial difficulties are temporary and you expect your situation to improve, loan restructure is often the better choice. It allows you to modify your repayment terms to fit your current circumstances without the long-term credit damage that comes with loan settlement.
2. Preserving your credit score
If maintaining a healthy credit score is important for your future financial plans, loan restructuring is the more suitable option. By continuing to repay the loan (albeit under different terms), you minimise the impact on your credit score, which is crucial if you plan to borrow again in the future.
3. Managing repayments over a longer period
Loan restructuring can help reduce the financial burden by spreading repayments over an extended period. If you are struggling with high EMIs, extending the loan tenure or lowering the interest rate can make the repayments more manageable, giving you time to recover financially.
Conclusion
Choosing between loan settlement and loan restructure depends on your financial circumstances. If you are unable to continue making loan payments and need immediate relief, loan settlement may be necessary, but be aware of the significant impact on your credit score. On the other hand, loan restructure allows you to adjust your repayment terms, preserve your credit score, and continue repaying the loan over an extended period. Consider your financial goals, credit score, and the terms offered by your lender to make the best decision for your situation.
