Did you miss a loan payment? You will usually get a delinquency period to clear the missed payment and get back on track. However, if you fail to pay your EMIs consecutively for several months, it is considered a loan default. Defaulting on your loan affects your overall financial credibility – and it worst hits your credit score. A poor credit rating below 650 makes it difficult to secure credit cards or loans in the future. Even if you manage to get a loan, the interest rates may be exorbitantly high. Don’t worry! There are always ways of rebuilding credit score after a loan default.
What Happens If You Default on a Loan?
First, it is crucial to understand the impact that loan default can have on your credit score.
- Impact on Your Credit Score
If you fail to repay your loan on time, it can negatively impact your credit score. With a lower credit rating, your future loan applications may get rejected, or you may be approved for a loan with exorbitantly high interest rates.
- Additional Penalties
In case of a loan default, your lender may charge additional penalties and fees. This includes legal fees, bounced cheque charges, and late payment fees. These additional charges can exorbitantly increase the total amount that you owe to the borrower.
- Getting Your Collateral or Property Seized by the Bank
If you have used your property or any other asset as collateral to secure a loan, lenders may seize it to recover the loan amount in case you default. So, you lose your valuable asset.
Your lender may also file a lawsuit against you in case of default but the latter causes major damage when your credit score goes down. Fortunately, there are various ways you can improve credit score after default.
Valuable Tips for Rebuilding Credit Score After Loan Default
Perhaps you lost your job and are no longer able to pay your EMIs. Or suppose your business has witnessed a major setback and your financial health is in a topsy-turvy. Whatever the reason for loan non-payment, do not let it affect your credit rating. Discussed here are a few proven ways you can improve your creditworthiness even after defaulting on a loan.
1. Work Towards Strengthening Your Credit Report
The first thing a bank or financial institution will look at to determine your creditworthiness is your credit report. Therefore, you should try to add more positive elements to your report that may help fade the negative history, such as a loan default or settlement. This involves paying all your monthly instalments and credit card bills on time. Timely repayments of all other loans and credit cards in hand can help improve your credit score quickly.
2. Create a Practical Budget
Assess your present financial condition and set a realistic budget, including your income, expenses, and outstanding debt. This will help you manage your financial commitments and set aside a budget to repay your debts.
3. Pay Your Outstanding Dues
If the bank or financial institution has flagged you as a defaulter, the best option is to get in touch with them and negotiate to close the loan. Once you repay the total debt amount, including all interest and penalties, you can raise a dispute with the credit score provider to update your status. This will change your status in the credit report from ‘default’ to ‘closed.’ Closing your loan is one of the best ways of rebuilding credit score after a loan default.
Remember that paying your outstanding dues is different from loan settlement. If your total outstanding amount is significantly high and you cannot pay the entire amount, you can talk to your lender for settlement. It means you pay a one-time amount to settle your dues, which is typically less than your total outstanding.
However, the loan settlement will be reflected in your credit report, which means you couldn’t repay the full due amount. This is considered high risk for banks and financial institutions, and it can be difficult for you to secure any form of credit.
4. Keep Your Credit Utilisation Ratio Low
Your credit utilization ratio indicates the amount of credit you are currently using compared to the total credit amount available to you. According to industry experts, you should keep your credit utilization ratio below 30–40% of your available credit. This will help improve the credit score after default.
5. Get Starter Loans
Even if you have defaulted on a loan, you can manage to get smaller loans or credit – especially when you purchase electronic goods or other items available on EMI nowadays. The rate of interest may be higher but when you repay them timely, it can help improve your credit score.
6. Avoid Too Many Credit Enquiries
When you have a low credit score, you should not apply for too many loans or make credit enquiries (even if it is a starter loan). Within a few months of being marked as a ‘defaulter’ by your lender, refrain from any more credit enquiries. When more number of enquiries reflect on your credit score, lenders consider you as credit-hungry. This may negatively impact your creditworthiness.
7. Obtain a Credit-Builder Loan
Many banks and financial institutions in India now have a credit-builder programme that can help in rebuilding credit score after a loan default. With this type of loan, the lender creates a savings account or provides a credit card where you make regular and timely payments. The bank will report your payments to the credit bureaus, and subsequently, your credit rating will improve.
8. Get a Secured Credit Card
Another way in which you can improve your credit score after default is by opting for a secured credit card. The lender will not take your credit score into account while giving you a secured credit card because you take it against a fixed deposit. It acts as collateral in case of non-payment. Once you get the credit card, make sure to pay the bills diligently and start improving your credit score. You may not see an immediate rise in your rating, but it will help you in the long run.
9. Check Your Credit Report for Duplicate Entries or Errors
You have defaulted on your loan, and it has already pulled down your credit score. Duplicate entries or inaccuracies in the credit report can further hurt your rating. According to experts, one out of five people reports an error on their credit report. This may be a minor mistake, such as incorrect spelling of your name or address, or something more serious, such as false payment records or fraudulent accounts.
If you find an error or discrepancy in the credit report, you should dispute it with the respective credit bureau and get it rectified. Take our word for it: getting erroneous entries removed from your credit report can help improve your score.
In Conclusion
Defaulting on your loan can be a setback for your credit score. Luckily, the impact is not permanent. Rebuilding your credit score after a loan default takes time, and you should stay committed to improving your overall financial health. It may take around 6–8 months of rigorous credit practices to see positive changes in your score.
