Example of Raman
Raman has a healthy salary and is currently living in a rental apartment. He planned to buy an apartment and hence took a home loan to combat the high prices and get ownership with a small EMI (for the long term). He is timely repaying the EMIs and has made a good credit reputation.
Raman has recently received an incentive from the office and plans to deposit it towards the home loan. He is confused about whether he should focus on quick repayment with a lump-sum payment or continue with the EMI and invest that money somewhere else.
Like home loans, borrowers have numerous other credit facilities that they plan to settle at some point of time. This develops a big hassle whether they should go to settle the debt with full payment or continue the EMIs?
Well, it's always recommended to settle your debt if you find additional money to repay. It won't hurt your credit as much as most people think. However, your credit facility is marked with a 'settled' tag which is considered negative from the lender's prospect.
What's Settling: Settling is the stage when you and the bank agree to end your loan and settle the rest principal amount alongside adjusted interest rates.
Here the banks agree to accept full payment that will end your loan and provide you NOC afterward. However, this information is forwarded to the credit bureaus as 'settled' on your credit report.
Commonly, it's always good to pay your debt as much as possible to come with a debt-free life. However, lenders always put a mark 'Paid in Full' on your credit account that other lenders consider while approving a new loan.
All credit accounts are shown in your credit report forever, even if you have paid them timely and settled them before time. Advance payment to your credit facilities will always bind with your credit score, which is a positive sign for the lenders as you never missed any EMI and has no penalties whatsoever on your credit loans.
However, you must know that running a long-term loan builds a strong credit history that makes it better for you to apply for another loan in the future.
Nowadays, most lenders let you pay fewer amounts (principle + less interest rate) to settle your credit account before its due date. Mostly, pre-payment or settling such accounts come with one-time fees. However, there are a few adverse aspects of paying full to your credit facility and foreclosure of your loan.
High charges (additional to Principal and Interest Rate) and shattered credit are the two prime factors that you will witness with the foreclosure of your loan account.
If possible, you should consider a debt management plan to find a better option to settle your debt without puncturing your credit score.
Even if you have made timely repayments and settled your account before its due date, your 'settle' mark will still be a crucial part of the credit score, and it will remain within your credit report for years (as mentioned earlier).
The first step is to evaluate how much funds you have and how much interest you pay with each EMI. If you have multiple credit facilities, start by paying for accounts with high-interest rates. Here, you should prefer the Debt Avalanche method. This method focuses on repaying high interest-rate accounts and moving down to lower ones.
If required, you can also go for the Debt Snowball method, where you can start paying the small loan amount and move forward to clear the bigger ones. In either case, your ultimate motive is to clear the debt and move out of the financial stress.
Go for Debt Consolidation: If you agree, it's better to proceed further to a debt consolidation loan and bring all loan amounts under one umbrella. Getting a consolidated loan will make a single repayment which will be easy to settle and manage.
You can transfer your balance to another card and pay off the amount whenever possible for credit card holders.
Enquire for Lump Sum Payment: Before you make a debt payoff strategy, it's better to communicate with the lender and ask for pre-payment options for your loan. If you are marked as a defaulter, it's better to work with a credit management firm to get the right lawyer for your help.
Ask For Credit Counselling Agency: Whenever you look forward to getting financial help for your debts, it's recommended to reach a credit counselling agency that can help you with a free consultation (initially) and let you manage your budget & debts smartly.
In case you are indulged in debt recovery and have legal actions against your loan accounts, the credit counselling agency will also help you in getting the right lawyer support.
Know Debt Payoff Options: Paying your debt collection funds is always a wise option to halt your process of reaching banks or taking calls from recovery agents. Paying debts is a better option than ignoring them completely. Ignoring has a strong (negative) impact on your credit ratings, creating issues in getting high loan approvals.
Undoubtedly paying full debt is a good option to eliminate the debt crisis from your life and enjoy every second to the fullest.
There are numerous cases when you encounter financial stress due to any medical emergency or unplanned mishap. You might miss out on some of your monthly payments in such a scenario.
So, if you have failed some repayments, it's always better to choose full payment. However, most experts suggest consulting your lender to agree upon foreclosure. E.g., you may ask the lender to lower your EMI, increasing your repayment duration.
If you can't convert/alter your EMI, it's better to go with full payment and foreclose your credit facility.
If lowering your financial burden is your ultimate motto, paying the full amount is wise. You are deducing the outstanding amount that will impose less interest rate by paying off debts.
You should also avoid using most of your credit limits. It is recommended to use less than 40% of the credit limit. This will help you maintain the right credit utilization ratio and maintain your credit score well.
It's always better to choose settlement if you encounter any of the below-listed reasons:
? You didn't qualify for a loan consolidation loan
? Your outstanding amount is half your annual income
? You are financially incapable of repaying the loan within the given time frame
Here are some crucial points about debt settlement, which you must note to make the right financial decision.
Not many of you know that your full outstanding amount isn't always considered for settlement. On average, the settlement is only made when your outstanding balance reaches 48% of your total debts. Moreover, you might pay a high settlement amount as some lenders impose high charges for foreclosure.
Consult with your lender to discuss settling your debts. It depends on whether the lender allows you to pay your debts or not.
If you are all set to make a debt settlement, you must know about the debt settlement scam. The most common scam in debt settlement is working with profit companies.
Numerous companies claim to eliminate your debt but charge you high fees, which isn't a profitable option to move ahead. Their high service charges will result in far more than what you expected to pay in debt settlement.
Also Read- What are Debt Consolidation Loans?
Another big scam originates when the agencies claim to communicate with your lender and settle your account. Unfortunately, they make you believe that your loan is paid off, which isn't true. This instead takes you to a higher debt supplemented with high-interest charges.
This brings us to a conclusion! Below are the outcomes based on your choice!
If Rohan prefers using his incentive to pay off the entire amount, there won’t be any red flags on his credit score. It means his credit score will always show a clean flag based on his prior payment history.
However, he may have to pay a higher amount, including high foreclosure charges and additional fees. This might not suit many of you as it drains your money in a single go.
If Raman gets an incentive lower than the full outstanding amount, he will have settlement as the only option. He can pay a small percentage of the outstanding principal, saving him from late fees and high-interest rates. Post settlement, lenders won’t chase you for full repayment until you miss out on your timely repayment again.
Yet, your credit report will get a settled flag that isn’t good for maintaining a healthy credit profile.
The ultimate outcome is that you should pay off the debts if debt-free life is your ultimate goal. Missing your repayments isn’t appreciated as it strongly impacts your credit score.