Refinance and Restructuring of Debt – What’s the Difference?
Refinance and restructuring of debt are both debt reorganization processes. Because they fall under the same umbrella, they are often used interchangeably even though they are completely different processes.
Basically, in debt refinancing, a new contract with better terms is initiated by the borrower to pay off the existing one. Debt restructuring on the other hand has to do with changing the terms of an existing contract.
This is the replacement of an existing debt (loan) with another one having more favorable terms and/or conditions. This new debt is used to pay off the existing debt. Student, mortgage, and credit card loans are some credits that can be refinanced. You can learn more about the process of acquiring working capital loans at Credibly
How it Works
Most commonly, consumers seek to refinance in order to lower fixed interest rates, switch from a fixed rate to a flexible one or vice versa, or alter the duration of the loan. The process of debt refinancing is more favorable to consumers with high credit scores.
Such consumers are able to get significantly lower interest rates than those with a low credit score. This is because banks and other financial institutions that offer this service trust consumers with higher credit scores to pay back in a timely manner.
How to Refinance
Refinancing works like taking out a normal loan. The first step is to ensure there are no issues with your credit score. As mentioned earlier, consumers with high credit scores benefit the most from refinancing. One type of loan that is eligible for refinancing are student loans. Some of the top student loan refinancing companies have various plans so everyone can receive the best rates.
Secondly, search for registered lenders offering better terms. Good refinansieringslån, which means refinancing loans in Norwegian, are available to consumers that qualify for them. Borrowers should double check to confirm that the new rates, payment frequency, and the duration of the loan are more favorable than the existing one.
Lastly, take the new deal to your lender to see what it is willing to offer. Many times, lenders are open to renegotiating terms as they risk going bankrupt if loans are not repaid. Getting refinancing from your lender is usually a better choice because certain fees can be waived off.
Pros and Cons of Refinancing
1. Debts that are refinanced to a lower rate can produce a significant amount of cash flow. This money can be invested to make profit and settle the new contract.
2. Refinancing debts helps to lower monthly payments and save a lot of money, especially in long-term loan contracts.
3, By refinancing, you can extend or reduce the loan term as you see fit for your current financial status. For example, a 10-year loan term may be extended to 20 years. However, the borrower would have to pay more in interest over the duration of the loan.
Alternatively, a 20-year loan term may also be shortened to 10 years if a borrower decides to pay off the loan much quicker. In this case, the borrower makes higher monthly payments but with a lower interest rate.
4. Multiple loans can be consolidated into one if lower rates can be gotten. This option also provides the convenience of keeping track of payments for one loan as opposed to multiple.
1. Borrowers end up paying more interests on loans when they extend their terms. Also, the option of lowering the loan term still comes with the cost of having to make higher monthly payments.
2. Refinancing can be very expensive with borrowers paying as high as 7 percent interest on the outstanding principal.
Debt restructuring is altering the rates and terms of existing loan contracts, as opposed to refinancing where a completely new contract is established to pay off existing debt.
Borrowers that restructure debt typically do so to change the frequency of monthly payments or extend the date of payment of the principal amount on a debt contract.
Restructuring is used by individuals and companies who are at risk of defaulting on loan repayments. It negatively affects a borrower’s credit score and that is why it is often used as a last resort.
How it Works
Borrowers restructure their debts to either avoid defaulting or going bankrupt. In this process, lenders extend the due dates for payments, reduce interest rates, or both. Lenders do not have much of a choice because they risk getting a lesser pay if such companies liquidate or go bankrupt.
Creditors and borrowers both have an interesting option when it comes to restructuring debt. This option is called debt-for-equity swap. Learn more about debt-for-equity swap here.
A debt-for-equity swap happens when a lender agrees to cancel part or all of a defaulter’s debt in exchange for equity- essentially something of value. In the case of a company, this equity could be in the form of stocks.
Pros and Cons of Debt Restructuring
1. Companies can save their business from going under by restructuring their debts to get more favorable terms. The debt-for-equity swap is one option companies and individuals can take advantage of to keep afloat.
2. By restructuring, borrowers are able to pay lower interest rates; an option that would otherwise not be open to them.
3. Traditionally, a borrower provides collateral or collaterals that have a monetary value equal to the loan amount they are applying for. This protects lenders from losing money should the borrower default in payment because creditors have the right to sell off those collaterals to recover their money. By restructuring their debts, borrowers can avoid this unpleasant situation because they get better interest rates and terms that they can easily meet.
1. A borrower’s credit score is negatively affected by debt restructuring. This is because creditors are more likely to give loans to people with high credit scores. A high credit score shows that a credit applicant is capable of repaying loans timely and according to the terms of the contract.
However, borrowers that restructure their debts are less likely to get more loans in the future because their loan records will be made available to creditors who will see their inability to repay loans.
2. Defaulters that restructure debts spend a longer time repaying them. This can be risky because their financial status may worsen in the future making them unable to repay their debts with even much better terms.
It’s always important to know exactly all the options available to you when making any decision, especially one that can affect you for many years to come. In this article, we hope we have provided enough information to help you have a better understanding of what it means to refinance and to restructure a debt.