Although refinancing and restructuring loans may appear the same, they’re two different procedures that often need clarification as one. In this article, we’ll explain the differences and similarities between these two procedures to help you make the right choice for your loan.
Before we begin, let’s look at the process of refinancing and restructuring loans.
What is loan restructuring?
Restructuring can be described as changing an existing loan to modify the conditions of the contract. People generally choose restructuring loans when facing the possibility of default and find it difficult to pay them promptly.
In simplest terms, Restructuring could be defined as a process that involves:
- Intensifying the loan repayment time
- Modifying the frequency of interest payments
- or reducing the loan EMI.
To facilitate the borrower to pay back the loan promptly. Restructuring typically occurs in the most dire situations when borrowers are on the edge of bankruptcy or are judged to be financially unstable and incapable of meeting the additional loans.
Restructuring loans is an urgent option for borrowers at risk of default. It is often negotiated when discussing modifying an existing loan contract because it is the only option to avoid default on loans.
Can loan restructuring influence your credit rating?
Yes, Restructuring will negatively impact your score on credit. This is why it is highly advised that you use Restructuring as the last option if you have no other options.
But, one-time Restructuring of loans doesn’t affect the credit score
The RBI announced the first of its kind once-in-a-lifetime restructuring benefit that applies to individual loans and corporate lending due in connection with the covid-19 epidemic. This initiative is designed to provide financial assistance for the millions of Indians affected financially due to this Coronavirus pandemic.
This is a massive relief for lenders and borrowers, as the restructuring process will be carried out without the need to classify the account as non-performing. But, be aware it is offered for a limited time until 2020 and must be reactivated within 90 days of the invocation date.
What happens during loan restructuring?
When it comes to the process of Restructuring, loans occur where the borrower and lender discuss the conditions of the existing loan contract, and both parties reach an agreement. It is suggested to notify your lender if you are ucannotyour loan on time or have been laid off, which has impacted your financial health. By enlightening, your lender can help because they could understand your financial situation and offer relief.
Any lender would not want their clients to default on loan repayment. The lenders believe that recouping the loan amount is preferable to the borrower declaring bankruptcy, in which case the lender cannot take back the loan amount. Therefore, most lenders agree to work with underwater borrowers to modify the conditions of the loan, such as prolonging the repayment time, removing late payment fees, or changing the amount of interest to be paid.
Banks are prepared to modify loans in the event of
- They can then recover their dues
- Banks are confident about the intention and capabilities of the lender
What is loan refinancing?
The term “loan refinancing” refers to applying for an additional loan or loan instrument with better terms than the prior one and can be used to pay off previous loans. People generally refinance loans when they find better terms on loans elsewhere.
An example of refinancing loans is applying for a new, less expensive loan and then using the loan proceeds to pay off the balance on an old loan. Refinancing can be a faster process than Restructuring, as it is more attainable and will impact the credit rating because the repayment record will reflect the original loan as being paid off.
Refinancing your mortgage is a brilliant idea.
Refinancing is possible for various reasons, including decreasing the interest rate on loans or consolidating loans, altering the structure of loans, or decreasing the total burden of loans. People with excellent credit scores will tremendously benefit from refinancing because they can obtain more favorable contract terms and lower interest rates.
Refinancing is possible to satisfy the following reasons:
- To reap more monetary benefits in the form of interest rates
- To get a longer term to repay
- To obtain additional funds
- For better services and features with the new lender
- To lower the amount of the loan
A sample of how loan refinancing and restructuring function:
Mr. X accepts the loan amount of Rs. 1 crore to fund his business with an annual rate of 4 percent p.a. for six years. But, suppose that two years later, the company of Mr. X is experiencing a decline. He’s unable to make the interest and loan. The lender issues regular notices to Mr. X demanding that he pay the loan EMIs and penalties.
The bank and Mr. X come to a settlement that allows Mr. X to have another six years to repay the loan. This is a case of Restructuring.
One year later, He realizes he can get a similar loan for only 3%, as the market has changed and his credit standing has improved due to a better balance statement. He accepts this loan at a lower cost to pay for the previous loan. Refinancing is the term used to describe it.
Although refinancing and debt restructuring sound similar, they are distinct procedures and may have different goals. Be sure to distinguish between them to pick the most appropriate one per your financial needs.