What is the difference between Debt Restructuring vs refinancing debt?

Debt Restructuring

In the simplest sense, it’s about changing the terms of an in-place contract (versus refinancing that begins with creating a new contract). A typical restructuring example is extending the deadline for the principal instalment on an existing debt contract or altering the frequency for interest-related payments.

Restructuring can be a good option in certain situations where the borrower is considered financially unstable and unable to pay the debt obligations. The restructuring may also affect your client’s credit rating, which is why it’s a last resort strategy.

Debt restructuring is a radical option used when debtors face the risk of default and are negotiating to modify the contract.

In restructuring debt, the borrower must work with the creditor to reach a compromise in which both parties benefit. If you are unsure if you can pay your loan on time or have been laid off and it affects your financial security, it’s usually wise to start discussions with a creditor.

They don’t want borrowers to default on loans because of the considerable expenses of bankruptcy. Most of the time, lenders are willing to discuss with underwater borrowers to modify the loan structure in any way, including a waiver of the late fee, extending the payment date, or altering the frequency and amounts of coupons.

Another alternative for established, large companies is to swap debt to equity. Debt-for-equity swaps are also possible when mortgages are involved. In these instances, households trade equity in their home to lower the mortgage payment. This is usually the case the restructuring process will permit the borrower to have more liquidity, which could later be used to replenish or sustain sources of cash flow that allow them to repay the loan contract they renegotiated.

Debt Refinancing

In debt refinancing, the borrower can apply for a credit or debt instrument that is more favourable than the initial contract and can be used to repay the prior obligation. One example of a refinancing scenario is applying for a brand new, lower-cost loan and using the funds of that loan to pay off the duties of the previously in place.

Refinancing is a more popular option than restructuring, and it is faster, more straightforward to get, and positively impacts credit scores because the payment history will reflect the completed loan.

There are many reasons for refinancing, but the most popular is lowering the interest rate on loans and consolidating debts, altering the structure of loans, and freeing money. People with good credit scores particularly benefit from refinancing to get better contract terms and have lower interest rates.

In essence, you’re changing one loan to another. Therefore, it is usually employed whenever there is an increase in interest rates which could affect the new debt contracts. For example, if interest rates are reduced due to the Federal Reserve, new loans and bonds will have lower interest payments, which is beneficial to borrowers.1

In this case, debt refinancing can enable the borrower to pay less interest over time for the same loan. It is crucial to remember that, when trying to repay loans before their due date, typically, fixed-term loans are characterized by the so-called”call provisions,” which penalize borrowers in the event of the loan being paid off early repayment.2 In these situations, the borrower must exercise due diligence when calculating the present value net of one loan over one.

Particular Concerns: The Cost of Bankruptcy

Why refinance or refinance or The primary reason is to reduce the risk to the borrower and the lender. Because of the legal costs imposed on both borrowers and creditors, the majority of problems with restructuring debts are resolved before bankruptcy is inevitable. On average, attorney costs in Chapter 7 bankruptcies range anywhere from $500 to $2,200.3

In addition, there are costs for filing government paperwork and credit counselling fees and debtor education charges in addition to the negative impact on the credit score.4 On the creditor’s side, if the loan was not secured and the lender pays the principal and the agreed-upon interest payment. The creditor must manage liquidating assets such as cars or real estate if the loan is secured. Most of the time, both parties want to avoid such consequences, so refinancing and restructuring are attractive options.