What is loan foreclosure?
Terminating any loan by repaying the total outstanding loan amount before the end of the tenure is called loan foreclosure, and this is pertinent with auto loans, personal loans, and home loans. Typically, borrowers do this to reduce interest cost, but it also creates a domino of credit-reporting triggers.
Immediate effect on your credit report
- Updated loan status: When you foreclose, the lender will report your property to the credit bureaus as “closed”. That’s accountability and timely payments, which is a good thing.
- No stem of negative: We don’t use terms like “default” and “settled”, which may impair credibility, to describe a foreclosure done in a way the lender thinks is appropriate.
Although the update is mostly good, there are nuances with scoring models that could result in a momentary hit to your score.
How long does it take to update the credit score after the loan closure?
- It will normally take about 30 – 60 days after the lender sends the update for the foreclosure to appear on your credit report.
- After that, the credit bureaus have the chance to check your report and change your credit score, if applicable, which could go up or down over the course of the next one to two cycles.
So, expect to see the complete update and score response one to three months after the completion date of final payments.
Why might your credit score dip after foreclosure?
- Fewer active credit mix: When you close a loan, you have one less active credit account and this may slightly affect your credit mix.
- Decreased average credit age: Most scoring algorithms will drop your average account age lower if you have closed an account in which you can no longer age.
- Decreased overall aggregate limits: If you also have balances on credit cards, having one less credit line may cause a decrease in your overall available credit if you have weight with your utilisation ratio.
Although you may see a small drop in the short terms with all of these changes, in the medium to long-range, the benefits usually outweigh the costs.
Ankit Mehra, CEO of GyanDhan expressed his opinion by quoting, “The impact on credit scores isn’t always immediately favourable. Loan accounts contribute to both the length of credit history and the credit mix. Closing a long-standing loan may temporarily reduce your score by shortening your credit timeline or decreasing credit diversity. To minimise short-term impact, it’s critical to ensure all EMIs are paid on time up to the point of foreclosure.”
“Always obtain a No Dues Certificate from the lender and check your credit report within a few weeks to verify the account is accurately marked as “closed.” Ultimately, foreclosure may cause a modest dip in the short term, but it strengthens your creditworthiness in the long run, especially when supported by other active, well-managed credit lines,” he added.
In conclusion, in the short term, closing a loan early may slightly reduce your credit score, but after the foreclosure is properly captured on your file, you can expect a bump of your credit score if you take good financial care of yourself, monitoring your credit report and managing your credit utilisation.
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