Loan Restructuring- All You Need to Know

Imagine a scenario where you feel overwhelmed by your debt and struggling to keep up with loan payments. The weight of the debt is causing stress, and you are not sure how to get out of this situation. This solution is called loan restructuring. It is a process that allows you to renegotiate the terms of your loan, making it more manageable. Loan restructuring is a powerful tool that helps you get back on track and achieve financial stability. Let's explore this solution together.
 

What is Loan Restructuring?

 
Loan restructuring is a process in which your lender agrees to modify the terms of a loan agreement to make your loan repayment more manageable. Restructuring can include extending the repayment period, lowering the interest rate, or altering the loan's payment schedule. The goal of loan restructuring is to help the borrower avoid default while assisting the lending recover as much of the loan as possible.
 
It is important to note that loan restructuring is distinct from loan forgiveness, in which the lender agrees to forgive a portion of the loan.
 

When to opt for a loan restructuring?

 

1. Improved Credibility

   If you obtained a mortgage loan during the early stages of your career, you may not be approved at a lower interest rate. The reason for this is a lack of credit history. However, as the years pass and you make on-time monthly payments, your credit history improves significantly. Therefore, you can contact your lender and negotiate for a better interest rate. 
    

2. Loss of Employment

   Job security appears to be a myth in the aftermath of the pandemic. Millions of people have lost their jobs as a result of the company's inability to generate expected revenue. If you lose your job but are saddled with significant debt, you are in a default-like situation. In such a case, it is best to contact your lender and request either a repayment schedule extension or a partial waiver of interest.
    

3. Multiple Debts

   It goes without saying that if you have several high-interest loans, your EMI burden will be extremely high. If you receive a windfall gain from stock trading, lottery winnings, or other sources, you may want to make partial repayment and restructure your loan for a much lower EMI. You could also look for a personal loan at a lower interest rate and use it to consolidate your debts.
    

What are various types of loan restructuring?

 

1. Loan Modification

   A loan modification is a process in which the lender alters the repayment terms to make debt management easier for you. Modification can include a reduction in the interest rate or tenure extension. For example, if you have a significant amount of credit card debt, the lender may agree to reduce the interest rate on the loan and extend the loan term to help the borrower become debt-free.
    

2. Debt Settlement

   Debt settlement occurs when your lender agrees on a lump sum payment to close your loan. The settlement payment you make is much less than the actual outstanding amount. Assume you have had a car loan for the past five years. You are having difficulty repaying your EMIs after successfully paying them for three years. The outstanding amount after three years is Rs 6,00,000. Your lender has agreed to settle your debts for Rs 3,00,000. This is known as loan settlement.
    

3. Debt-for-Equity Swap

   A debt-for-equity swap is a financial transaction in which a company exchanges debt for equity shares. It implies that instead of repaying the outstanding amount, you give the lender an ownership stake in your company in exchange for the debt. This type of transaction can be beneficial if your company is struggling financially, as it can help to reduce your overall debt burden and improve your balance sheet. It can also benefit the lender, as they receive an ownership stake in the company and can potentially earn a return on their investment if the company's fortunes improve. Debt-for-equity swap restructuring method is uncommon in India.
    

4. Debt-for-Debt Swap

   A debt-for-debt swap is a financial transaction in which you exchange one debt for another. It implies that instead of current debt repayment, you intend to take on a different debt having different terms and conditions from the same lender. For example, you might swap a high-interest debt for a lower-interest loan or a short-term debt for a longer-term debt. 
    

5. Bondholder Haircuts

   A haircut is a reduction in the value of a bond imposed on bondholders as part of a debt restructuring or financial bailout. The scenario can occur when a bond issuer (corporation or government) fails to repay its original borrowing and negotiates a debt restructuring with bondholders. For example, if a bond issuer imposes a 10% haircut, bondholders would only receive 90 paise on every rupee of bonds held.
    

Also Read: Debt Consolidation vs Debt Settlement: Know the difference
 

Advantages of Debt Restructuring

 

• Reduced financial burden

  By restructuring the debt, you can negotiate for lower interest rates, longer repayment periods or even a reduction in the principal amount. This can make the debt more manageable and reduce your overall financial burden.
   

• Avoiding bankruptcy

  Debt restructuring can be a way for you to avoid bankruptcy. It allows you to keep your business or assets while you work on paying off their debt.
   

• Improved cash flow

  By reducing the debt burden, you can have more cash available to invest in your business, pay your staff or invest in advanced technologies to improve your company's financial situation.
   

Disadvantages of Debt Restructuring

 

• Loss of assets

  Sometimes, you might have to give up assets to secure the debt restructuring. This scenario is usual in the case of collateralised financing.
   

• Damaged credit score

  Debt restructuring negatively impacts your credit score. However, do remember that not all restructuring is bad for you. Your creditworthiness improves if you choose partial prepayment. On the other hand, loan settlement is considered bad.
   

• Negative impact on shareholders

  In the case of corporations, debt restructuring is viewed as an adverse corporate action that harms shareholders by diluting their stake in the company.
   

• Costly

  Debt restructuring, in the case of corporate loans, can be expensive as it involves legal and financial experts to work out the terms and conditions of the new debt.
   

What is the RBI's one-time debt restructuring scheme?

 
The Reserve Bank of India (RBI) has implemented a one-time restructuring scheme for various loan categories affected by the COVID-19 pandemic. The restructuring scheme was announced in August 2020 and aimed to help borrowers affected by the economic fallout from the pandemic. One-time restructuring applies to standard accounts that were classified as 'Standard' on March 1, 2020. Other requirements for choosing this scheme were-
 

• The borrower must not have availed of any other resolution plan under the RBI's framework for stressed assets prior to the date of invocation of the current scheme.
• The borrower should not have defaulted in meeting its payment obligations to any of its creditors, including public financial institutions, statutory central/state government bodies, and local bodies.
• The borrower should be able to demonstrate the future viability of its business and the ability to service its debt following the restructuring.
• The borrower should also be able to provide additional securities as required by the lender.

 
It is important to note that the scheme is voluntary and optional for the borrower. The restructuring decision will be based on mutual agreement between the borrower and the lender. The RBI has asked banks to ensure that the restructuring is done transparently and objectively and that all stakeholders' interests, including depositors, are protected.
 
Also Read: How To Improve Your Credit Score After A Loan Settlement?
 

Conclusion

 
Loan restructuring makes repayment more manageable and affordable. The process includes changes to the interest rate, loan conclusion date, or payment schedule. It can be beneficial for individuals and businesses to avoid default and maintain access to credit. However, it's important to note that loan restructuring may have an impact on a credit score, and it is not a guaranteed solution. It is always better to consult a financial advisor before taking any decision.