Is debt settlement legal in India?

Debt settlement allows borrowers to negotiate with lenders to pay less than the full loan amount. If any borrower is unable to pay their loan properly, they can settle it. Loan settlement in India is both possible and legal. Lender's approval is necessary in this process, and it can affect your credit score too. In this blog, we are going to understand how personal loan settlement and other settlements work and what their legal aspects are that help borrowers in making decisions. 

Key takeaways 

• Debt settlement is a process where a borrower negotiates with a lender to repay less than the total outstanding loan amount.
• Borrowers facing serious financial difficulties who cannot repay their loans in full generally use them.
• Debt settlement is legal in India. It allows borrowers to negotiate with lenders to repay less than the total outstanding debt.

Debt settlement can negatively impact your credit score and may appear as "closed” on your credit report.

Some borrowers do not pay regular payments and save money for loan settlement, which can lead to payment penalties, collection calls, and additional financial stress.

What is debt settlement in India?

Debt settlement is debt reduction, debt negotiation, debt resolution, or you can also call it debt relief. It is a simple process of negotiation that you do with your lender to pay less than the total amount you owe. Lenders can also forgive a part of the outstanding debt if you pay the decided amount. 

The decided amount is paid in a lump sum, but there are some lenders who allow installments. 

For example: 

Gaurav is an Accountant in a Pune-based company. He had a personal loan of ₹6,00,000 but lost his job in a mass layoff. Now he doesn't have a penny to pay as EMI. Then he talked about it with a bank, and they agreed to a debt settlement. Instead of paying the full ₹6,00,000, Gaurav paid a one-time settlement amount of ₹3,80,000, and the remaining ₹2,20,000 was waived by the bank. So Gaurav did a personal loan settlement. 

Did you see how the bank forgave Gaurav's debt?. This agreement to close the loan for less than the total outstanding amount is called debt settlement.

What is the process of loan settlement in India?

Now you know the basic concept of loan settlement. This loan settlement isn't allowed to anyone. It's mainly available for Unsecured debts like credit card debt, personal loans, and medical bills. Secured loans like home loans and car loans can't be settled. 

If you want to settle your unsecured loan, you need to talk with your creditors. If they agree, some portion of your loan can be settled. You are allowed to pay a decided amount of money in a lump sum or installments. When you pay this money, the remaining amount is considered settled, and then you don't have to pay anything. 

Your lenders can agree on a loan settlement because they might think it is better than receiving no payment at all. But this negatively affects your credit score. So, before settling your loan, decide wisely. 

Is loan settlement legal in India?

Yes, absolutely. Debt settlement is legal in India, and no law can prevent any borrower from going for the loan settlement. If you too want to settle your loan, keep these things in mind:

• You should negotiate with your lender directly or through a debt settlement company, which is also called a debt relief company.
• You need to get the settlement terms in writing before making any payment.
• After the agreement, you need to make the agreed payment within the specified time.
• When you complete the payment, you should collect your No Dues Certificate or Loan Closure Letter.
• And most importantly, never lose your debt settlement documents. 

So you can legally settle your loan in India, but the problem is that this loan settlement can affect your credit score badly. So it is advisable that before considering this option, you should consider other alternatives like debt consolidation or loan restructuring. 

Under Which Law Is Debt Settlement Allowed?

Loan settlement in India is governed by different laws, and these laws protect both lenders and borrowers. 

1. Indian Contract Act, 1872

This act allows both lender and borrower to reduce, change, or settle a loan. That means not only borrowers but also lenders can settle loans. 

2. RBI guidelines 

You already know that the Reserve Bank of India is the regulatory body of banks. RBI guidelines allow banks to offer One-Time Settlement (OTS) schemes. This scheme is for eligible borrowers who are facing financial difficulties.

These guidelines mandate:

• Banks should follow fair recovery practices.
• Borrowers should be informed about available settlement options.
• All settlement terms should be properly documented.

3. Insolvency and Bankruptcy Code (IBC), 2016

This is the legal framework that resolves debt and insolvency cases in India. 

4. Negotiable Instruments Act, 1881

This act is for the loan repayment cheque bounce cases.  In many cases, borrowers and lenders choose to settle the matter before it reaches court.

All the above acts are governed by the Indian government. So the process of loan settlement should be legal. It should always be done through a written agreement. And you must collect a No Dues Certificate or a Loan Closure Letter. 

What are the Legal Requirements for Debt Settlement?

You need the following things for debt settlement.

• You need a written settlement agreement.

You should have details of the agreed repayment amount.

A Loan Closure Letter or No Dues Certificate after payment is a must. 

Copies of all settlement documents.

This is essential information before and after debt settlement. Make sure you do not lose any. 

Can a Bank Refuse a Settlement Offer?

Yes, banks can refuse your loan settlement request. They have the right to do so. Debt settlement is not the legal right of the borrower.  Banks first check your financial situation and then decide whether or not to grant a loan. 

Here are the things that banks check:

• Your current financial condition.
• Your repayment history.
• The reason for your loan default.
• Whether you can repay the loan in the future.

If the bank wants to continue your loan, then it can reject your settlement. If you are in real financial trouble, the bank may consider a settlement or a One-Time Settlement (OTS).

Pro tip: Whenever you apply for a loan settlement, provide your financial details and supporting documents. It can improve chances of approval. 

When Should You Consider Debt Settlement?

Practically, debt settlement is not easy to do. It is the last option you can opt for as a borrower. This is only applicable to those who are struggling financially and can not repay the loan. 

Banks approve debt settlement only if:

• Your financial condition isn't good.
• You are facing problems like job loss, medical emergencies, and loss of income.
• You missed a payment, and now you are not able to pay the due amount.
• When you are not eligible for debt consolidation and balance transfer.
• You have enough money to pay in a lump sum.
• When you want to avoid legal action. 

If you are facing any of the above problems, then you can go for debt settlement. 

Is Debt Settlement Safe for Borrowers?

Practically, debt settlement is the last option that borrowers choose. It reduces your debt, but it has some risks. Now what are those risks? Let's understand.

1. If you go for debt settlement, your credit score can be lower, and in the future you won't get a loan easily. 
2. Late payment charges and interest may continue until you finish the settlement.
3. Lenders can ask you for repayment if you did not pay during the negotiation. 
4. Lenders can reject your settlement request because it is not the borrower's legal right.

So, if you are going for debt settlement, consider all the above risks. 

Conclusion 

We saw the example of Gaurav, who was no longer able to pay his debt, so he simply asked his bank for debt settlement. The bank agreed, and his loan was settled. Many borrowers go for this option when they have no other alternative. 

Debt settlement is the final resort for the borrower. It is legal in India, but banks are not bound to approve each settlement. This process allows borrowers and lenders to mutually agree on settling a loan for less than the total outstanding amount. 

Frequently Asked Questions 

What happens if I don't pay a personal loan and I leave the country?

The bank can still try to recover the money. Your credit score will also go down.

Can I get a new loan after the settlement?

Yes, but it may be difficult until your credit score improves.

Will creditors accept a 50% settlement offer?

Sometimes. It depends on the lender and your financial situation.

How to clear 20 lakh debt?

It means recovery agents should not contact borrowers before 7 AM or after 7 PM.

What happens after 7 years of not paying debt in India?

The loan record may stop affecting your credit report, but the debt may still exist.

Can loan defaulters go to jail?

Usually, no. Not paying a loan is a civil matter, not a crime.

Does CIBIL improve after settlement?

Yes, but slowly. A settled loan can affect your score for some time.

Can a bank come to the home for recovery?

Yes. Banks or recovery agents may visit, but they must follow RBI rules and behave properly.