Unlike bankruptcy, you still pay some (or all) of your debts when you restructure. You just have more lenient terms. Creditors are often willing to work with you on restructuring your debt because they will receive more money than if you filed for bankruptcy. You can restructure almost any type of debt, including credit cards, student loans, mortgages, and auto loans.
Example of Debt Restructuring
Say you’re falling behind on your mortgage payments. You call your lender and explain your situation. They agree to help make your payments more manageable. Your lender could do this by extending the length of mortgage, lowering the interest rate, or changing the type of loan. For example, if you have a variable-rate mortgage, your lender may agree to modify it into a fixed-rate mortgage so you have a predictable monthly payment.
Types of Debt Restructuring
There are several types of debt restructuring. Some are for individuals and families while others are reserved for companies.
Loan modification: A loan modification is a change to the terms of your loan, such as the interest rate, monthly payment, or length of the loan. Loan modifications are typically used to make your mortgage payments more manageable. Informal debt repayment agreements: You and your creditor can negotiate informally to come up with a new repayment plan. This option is usually only available if you’re behind on your payments but not in default. Formal debt repayment agreements: Formal debt repayment agreements, also known as special forbearance agreements, are legally binding contracts between you and your creditors. These agreements can be used to restructure both secured and unsecured debt. Debt settlement: Debt settlement is when you negotiate with your creditors to pay less than what you owe. This is typically only an option if you’re unable to make your payments and are facing bankruptcy. Debt-for-equity swap: This happens when a creditor or lender forgives part of a company’s debt in exchange for a stake in that company. Bondholder haircuts: In this type of restructuring, bondholders agree to take a loss on the value of their bonds. This can happen if the company is not doing well and is unable to make its interest payments. Debt-for-debt swap: This is when a company takes on new debt to pay off its existing debt. This can be done by issuing new bonds or taking out a loan.
Each type of debt restructuring has its own advantages and disadvantages that you’ll need to consider before making a decision.
Pros and Cons of Debt Restructuring
Pros Explained
Provides financial relief: Debt restructuring can help lower your monthly payment or extend your repayment period, giving you some breathing room in your budget.You can avoid defaulting on your loan: If you’re struggling to make your monthly payments, debt restructuring can extend your repayment period, lower your interest rate, or even have some of your balance forgiven.
Cons Explained
Negotiating takes a lot of time and effort: One of the main disadvantages of debt restructuring is that it can take a lot of time and effort to negotiate with your creditors. This can be especially true if you have a lot of debt.It’s not always successful: While debt restructuring can be a good way to get more favorable terms from your creditors, it’s not always successful. Your creditors may not be willing to agree to new terms, or you may not be able to reach an agreement that works for both sides.
Debt Restructuring vs. Bankruptcy
When you restructure your debt, you work with your creditors to come up with a new repayment plan. This can help you get back on track with your payments and avoid defaulting on your loan. Bankruptcy, on the other hand, is a legal process that can discharge some or all of your debts. This can give you a fresh start, but filing for bankruptcy is expensive and will stay on your credit report for seven to 10 years. Debt restructuring is different in that you work with your creditors to come up with a new repayment plan. You typically restructure when you feel stretched thin by your finances and want to avoid defaulting on your loan.
Debt Consolidation
Debt consolidation is when you take out a new loan to pay off your existing debt. This can be a good option if you’re struggling to make multiple monthly payments. But it’s important to understand that debt consolidation doesn’t reduce the total amount of debt you owe.
Debt Deferment
Debt deferment allows you to temporarily stop making payments on your debt. This can be a good option if you’re experiencing financial hardship and need some time to get back on your feet. But interest may continue to accrue on your debt during the deferment period, which can mean you end up owing more money in the long run.
Bankruptcy
Filing for bankruptcy should be a last resort. It can have a major impact on your credit score and make it very difficult to get approved for new loans or lines of credit. However, if you’re struggling to pay your debts, it may be the best option for you.