Debt Restructuring refers to a process of modifying one’s debt obligations. While it is used in many different types of debt, the primary use is regarding credit card debt. Other such services include personal loans, mortgages, and student loans. In general, it involves reducing the amount owed or extending the time for repayment without drastically altering the initial terms or amounts involved. Debt Restructuring can be used as a debt management tool by individuals and businesses. As an alternative to bankruptcy for individuals, it is a valuable tool for re-establishing one’s credit rating and financial stability. Credit rating agencies note that one of the benefits of debt restructuring is that the process is quicker and more effective in helping people to get back on their feet than bankruptcy.
Reason for Debt Restructuring
Debt restructuring is done when the debtor cannot affordably repay their debts. The debtor may have incurred the debt over a shorter period or has experienced an unexpected financial hardship that has prevented him from repaying the debt. Debt restructuring involves negotiating with creditors and asking them to defer payments, reduce interest rates, increase periods for repayment or forgive some of the principal balance owed. In some cases, creditors agree to these requests; however, some are unwilling to restructure the debt and will initiate debt collection procedures, including a credit report freeze and account repossession.
Debt restructuring can be done for both secured and unsecured debts. For secured debt, the debtor pays the amount owed in full or makes monthly payments. These are “repayment plans” that give the debtor more time to pay back their debt with a lower monthly interest rate.
How to Achieve Debt Restructuring?
Debt restructuring is accomplished by contacting creditors and having them either agree to a payment plan, forgive part or all of the principal amount owed, or reduce the interest rate. These negotiations may be done individually or through a group, such as a credit counseling agency. Even though debt restructuring may be beneficial, it is not guaranteed that one will achieve it based on the quality of their credit history.
1. Debt for Equity Swap
A debt-for-equity swap is a contract in which the creditor agrees to sell the debtor’s old debt and instead provide equity in the debtor’s new business. This can be more beneficial than other debt restructuring types because it allows the debtor to maintain employment, but with reduced debt obligation, and continue paying interest on their existing loan. This type of swap is similar to a loan-for-debt arrangement where both parties take out a loan to purchase a condominium or business at an above-market price. The creditor does not have an established security interest in the collateral for the loan and thus cannot benefit from foreclosure or repossession.
2. Bondholder Haircuts
Bondholder haircuts are a type of debt restructuring in which bondholders will forgive or reduce their interest rate and value their original amount owed. This is done to obtain an updated information resource by stimulating economic growth. This type of restructuring is less common than others because it is more complicated and also because the government has reduced the incentives to do so recently. In addition, large companies typically have a diversified bondholder base that may be unable to agree on a deal.
3. Informal Debt Repayment Agreements
Informal debt repayment agreements are made to reduce interest and pay off the principal balance of a debt. This can be done through a negotiation with a creditor or by utilizing an agreement between the debtor and the creditor. For example, upon completing or receiving an education at one of the top-ranked universities in the world, students who have student debt may negotiate with their lenders to reduce interest rates and end up paying off their student loans in full upon completion.
Debt Restructuring vs. Bankruptcy
Debt restructuring is a form of debt relief that is typically done through an informal process with the help of a credit counselor. Individuals and businesses may see the benefits, but it is not the legal equivalent of filing bankruptcy, and fees are still associated with it. Bankruptcy can be filed if a person loses their job, cannot pay their debts, and becomes insolvent. This step allows them to establish a new financial footing, reduce or eliminate their debts and improve their credit history. Bankruptcy does not involve negotiating with creditors, and it is considered a last resort for debtors. It is also possible for someone to file for bankruptcy after a successful debt restructuring, but it can be more difficult to obtain relief under these circumstances. A common way of debt restructuring is reducing or canceling the interest rates on credit card balances and paying the minimums required by the bank on debts owed.
Debt Restructuring vs. Debt Refinancing
As with debt consolidation, debt restructuring can be accomplished by refinancing debts or other financial obligations. Debt restructuring requires changes to the terms of the original contract. For example, a debtor may negotiate a new interest rate for their home mortgage or car loan. The downside to this type of restructuring is that if payments are not made on time, a default will occur, and fees will be added to the remaining balance. This will be added to the overall debt and make it even harder to repay. The process of refinancing may also be more complex than debt restructuring because one must go through all the initial steps of seeking lender approval, submitting application documents, and undergoing credit checks.
Conclusion
Debt restructuring is a process in which a creditor may agree to modify the terms or conditions of the original contract. This is done when one cannot meet their obligations on the original contract and is facing high-interest rates and excessive fees. Those who seek out debt restructuring will typically do so through an informal process with the help of a credit counselor or through mediation with creditors.
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