Debt restructuring is a debt management option that allows individuals, companies, and even countries to minimize the risk of defaulting on their unsecured debt. Restructuring options such as negotiating lower interest rates offer a less expensive alternative to filing for bankruptcy when you are in financial distress. It can also work to the benefit of the lender and the borrower.
Difference between debt restructuring & debt refinancing
Restructuring and refinancing a debt are two different processes. Still, they invoke a similar image – that of a desperate company or individual on the verge of bankruptcy making the last-ditch effort to stay afloat. Both debt reorganization processes are often implemented to strengthen a debtor’s financial outlook, but the two concepts are entirely different.
Generally, restructuring debt involves altering the existing debt contract to lower the debtor’s risk of defaulting on payments. It is often done when the borrower is under financial distress or financial difficulty that could prevent them from making timely payments on their loan. Examples of typical restructuring include lengthening the specific due date for a principal payment on the debt contract, negotiating better interest rates on loans, or altering the frequency of interest payments.
On the other hand, debt refinancing involves a borrower applying for an entirely new loan or any other debt instrument with better terms compared to the previous loan contract. The new loan can be used to pay off the previous obligation. A great example of debt refinancing would be seeking a new, low-cost loan and using it to pay down the liabilities of your current loan.
How debt restructuring works
As mentioned earlier, restructuring debt involves making a proposal to your creditor and offering to pay off your outstanding debt on different terms compared to what you had originally agreed to. If your creditors agree to restructure your unsecured debt, you have a chance of paying back a lower amount and on better terms that may be affordable to you.
If you’re struggling to meet your financial obligations, you still have options. In fact, you may be wrong to think that you must pay off your debts or file for bankruptcy. At the same time, it’s a misconception that you can opt for a debt settlement or restructuring plan without scathing your credit score or credit rating.
Once you realize that your total debt has hit a point where your total income can’t sustain debt payments, and you have exhausted your available credit, most creditors will think you intend to file for bankruptcy. And that means they might end up with absolutely nothing. Restructuring is one of the ways creditors can salvage part of your debt and starts with a new proposal that you make to your existing creditors.
If the creditors accept your proposal, you will be able to make monthly payments (at better terms) or even a one-time payment to settle your debt. If done correctly, debt restructuring allows you to pay down your debt on affordable terms, regain control over your cash flow, build your finances, and finally get out of debt.
Will restructuring debts affect your credit score & credit rating?
The primary objection to restructuring debt is that it negatively affects your credit score. However, your credit rating should not be the sole criteria you have, especially when considering various debt settlement and repayment options. In fact, you must also consider how a specific debt management approach will impact your long-term financial goals.
Remember, you can still reestablish and improve your credit rating or credit report after restructuring your debt successfully and achieving full debt repayment. But the cash you pay out every month to service your debt is gone and isn’t coming back. This is the only hurdle for most Canadians in debt, particularly those who have been taught that they must preserve their credit score at all costs.
It’s important to mention that this attachment to your credit history and credit report can cost you thousands of dollars. For instance, you can improve your credit rating after a few years, but it might take more than ten years to pay down $60,000 in unsecured debt! So, considering the overall impact of restructuring a debt on your credit report, you should also know that filing for bankruptcy results in an R9 credit rating!
Final thoughts
Debt restructuring is a win-win for both debtors and creditors because you (the borrower) get to avoid bankruptcy and your lender typically gets more than they would have if you filed for bankruptcy. Although it is possible to negotiate with your lenders directly, it is recommended to seek the help of experienced and reputable debt consolidation and management experts.
