Loan restructuring is a process where you request the bank/NBFC to negotiate the terms and conditions of an existing loan. The intention of reorganizing a debt is to make it easier for a borrower to repay the outstanding amount and thereby reduce the loan burden. It saves you from defaulting on the loan. This choice also allows the bank to find a way to recover the due amount from the borrower. However, the decision to reschedule the loan may leave an impact on your credit profile.
It may also leave other effects, the most common one being a higher total cost of borrowing. If you think that you want to have a loan restructured then contact the lender. The following are the outcomes you may expect:
- You may both work out a favourable new repayment plan
- Either the creditor will agree to lower the rate of interest or extend the loan tenure
- In special cases, the financial institution may even reduce the borrowing cost considerably
- This is done through writing off a part of the interest/principal pay-out
Remember that rescheduling a loan is not available to all. The bank/NBFC may only consider the request if it thinks you are unable to repay the existing debt due to an unavoidable financial and liquidity issue. In the post below, we will discuss about – why you should choose loan reorganization, alternatives to it, reasons to avoid debt restructuring, impact of a new repayment plan, and how companies can get loans reorganized easily.
Why Choose Loan Restructuring? What Are the Alternatives?
You may choose to reshape your loan in case of severe financial problems. Usually, these issues cannot be easily dealt with. And under such circumstances, the bank/NBFC may offer a viable loan restructuring plan. This will allow you to pay off the outstanding dues. You can avoid being a loan defaulter and reduce the negative effect on your credit score. There are two more choices available to manage a loan that you are unable to repay.
- Loan Refinancing
When you request the creditor to reschedule the debt, then the latter may reduce the interest/principal amount or extend the repayment term. But in case of debt refinancing, you transfer the old debt to a new provider. The new lender offers a lower rate or better tenure option. This way, you can find a cost-effective way of repaying the loan.
- Filing for Bankruptcy
In debt restructuring, you can negotiate with the financial institution for the existing loan interest rate, tenure, and other terms and conditions. At times, the lender may enforce or suggest this option. But if you are facing a huge financial difficulty, then you may defer the payments by filing for bankruptcy. A bankruptcy entails that you do not have any liquid funds to repay the loan. The level of default here is usually huge. This could be perhaps there have been several loans that you could not repay.
On filing for bankruptcy, you can avail a legally enforced pause. Here, you have to work with the financial institution as per the court order for a possible repayment plan. If you are unable to adhere to the new repayment plan, then you have to liquidate your assets to repay the creditor. It is then the court that decides the repayment terms.
When Should You Avoid Loan Restructuring?
While loan restructuring may seem feasible to you, do not choose it until mandatory. This is because reorganizing a debt increases the borrower’s total cost. Here are the instances when it is better to not opt for a debt restructuring:
- A Vague Repayment Plan
You may choose debt restructuring only if you have a proper repayment plan for the same. Otherwise, you may run into a debt trap once again. Consider all your present and future expenses and incomes. These details will help you draw a repayment plan that you can follow meticulously. So, understand if you can truly meet up with the terms of the new repayment plan. Only then go ahead with it. Because the implications of defaulting on a rearranged plan, could be serious.
- Another Loan or Balance Transfer
You may choose an alternative to loan restructuring i.e., take a new loan to pay off the existing loan. You may take a loan against an asset. Examples of such options are a gold loan or loan against Fixed Deposit. These may come at a lower rate than unsecured loans. For instance, you may want to reschedule a personal loan or any other unsecured loan. Now, you can take a new loan at a lower rate, and pay off the higher interest loan.
You may also choose loan balance transfer. Here, you have to shift the original loan to a new bank/NBF that offers a lower interest rate or longer tenure. This way you can easily manage your EMIs without having to replan the debt.
- Lack of Income or Nearing Retirement
When you get a loan rearranged the burden of repayments also increases. This is especially true if the loan duration lengthens. It means you have to pay smaller EMIs, but a higher interest pay-out. Or the bank/NBFC may convert the overdue amount into another credit facility. So, if your income source is nil or limited, then it is not advisable to select debt restructuring.
Also, if the tenure goes beyond retirement or close to it, then you may not have sufficient funds for repayment. If you choose to reorganize the loan even then, then the financial strain may increase. Also, your retirement income or plans may go haywire due to lack of liquidity to meet the newly restructured plan.
- Sufficient Funds for Loan Repayment
If you already have a good source of income or ample funds to repay the loan as per the existing terms and conditions, then debt restructuring is pointless. Even if you want to direct the funds elsewhere than repay the original loan, you need to weigh the pros and cons to it. This is necessary, as the loan restructuring process may stretch the loan tenure. Due to the snowballing effect on the due interest, you have to pay a lot more than you would have to on the original loan.
- Jeopardizes Your Financial Aims
Though debt restructuring may seem appealing, it comes at a great expense. It may have a huge impact on your financial goals, be it a short-term or long-term one. For instance, you may have a plan to contribute towards an emergency fund or make a new investment. But due to reorganizing the loan, you may now not have enough funds for these goals. So, whenever you take a decision to replan a loan repayment, think twice, and take an informed call.
What is the Impact of Loan Restructuring?
Here are the effects of reorganizing a loan:
- Whenever you select debt restructuring, the lender will report it to the credit bureau
- The loan account in your credit report will show as – Restructured
- This may have a negative connotation about your credit behaviour
- The next time when you apply for a new loan, lenders will undertake a greater scrutiny
- They will strictly analyse your financial profile than usual, before taking a decision to approve the loan
- Thus, debt restructuring, if not necessary, should be your last resort
3 Ways a Debt-ridden Company Can Restructure its Loan
It is not only individuals who may run into financial trouble or face difficulties in paying off a loan. Companies that borrow funds may also encounter a similar hurdle. So, to reorganize the terms of a loan repayment, companies can enter into a direct negotiation with the lender. Here are the ways for loan rescheduling:
- Informal Debt Repayment Agreements
Like individual borrowers, organizations willing to have their debt replanned may ask the creditor to provide them with a lenient repayment term. They may even request to write off a portion of the due amount. The company can directly approach the lender to discuss the new repayment terms. And then the concerned parties can reach a mutually acceptable loan restructuring plan.
- Bondholder Haircuts
Here the companies negotiate with its bondholders. The organization in question will have outstanding bonds. It will request the bondholders to repay at a discounted level. This is possible by cutting off or reducing the principal payment or interest.
- Debt for Equity Swap
The lender will accept to part with a specific amount of overdue. But to agree for this, it will ask for equity in the company. This method of reorganizing a loan is chosen by companies with a large base of liabilities and assets. This is because forcing such a company into bankruptcy may not benefit the creditors. Rather, it may seem wiser for the lender to let the organization to operate while have a stake in its operations.
Final Words
As understood, loan restructuring is a way out for those in financial distress. It provides some relief to the borrowers who are unable to repay loans due to a variety of circumstances. But remember that debt reorganizing plans comes at a cost. It may increase expenses, disturb your financial goals, impact your credit profile, and have further repercussions. So, it is important that you weigh your options and go for debt restructuring, only if ultimately necessary.
