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Debt Restructuring: What It Is and How It Works
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Debt restructuring can be a crucial lifeline if you’re struggling to pay your bills. It occurs when a creditor changes the terms of your loan agreement, thereby making your debt more affordable. Loan restructuring can take different forms, from permanently modifying your loan with a longer repayment term to lowering your interest rate or current balance.
To get a handle on debt restructuring and whether it’s best for you, let’s answer the following questions:
What is debt restructuring?
When your finances are stretched thin, you may have to start picking which bills to pay. Missing a payment can lead to late payment fees, which can hurt your credit and cause creditors to seize any collateral used to back the debt, such as with auto loans. But if you reach out to your creditors, they may offer debt relief options.
A temporary hardship program could let you skip several payments or avoid certain fees. During a serious setback, or if you’re already months behind on bills, creditors may make an unusual offer to restructure your loan agreement. This is often called troubled debt restructuring.
Whether you’re looking for credit card debt restructuring or loan restructuring on an installment loan, the restructuring can take different forms.
Types of debt restructuring
One debt restructuring example is when homeowners get a mortgage loan modification. The loan could be modified (i.e., restructured) in several ways:
- Extending the repayment term
- Reducing the interest rate
- Reducing the remaining balance
- Bringing a past-due account current and adding the unpaid portion back to the principal balance
Other types of lenders and credit card issuers may offer similar types of debt restructuring that could help you keep your property or avoid defaulting on the debt.
Debt restructuring can also result from filing Chapter 13 bankruptcy, which lets you repay the included debts with a court-approved repayment plan. The repayment plans generally last for three to five years, after which the remainder of the included debts are discharged.
How does the debt restructuring process work?
If you’re seeking debt restructuring with a creditor, you can follow these steps. (For information on filing Chapter 13 bankruptcy, click here.)
- Contact the lender and explain your financial difficulties: Debt restructuring is a creditor’s response to borrowers who are struggling to afford their bills. Ideally, you’d contact your lender once you realize you won’t be able to afford payments. Reaching out to your lender could be better for your credit than waiting for the lender to contact you, as they’d only do so after you’ve missed payments and already accrued fees.
- Wait for a lender response: Lenders generally aren’t obligated to help you and may stick with the original terms of the loan. If they choose to do so and you can’t pay the bill, you may be charged late fees and your late payments could be reported to the credit bureaus. After falling far behind, your account may be sent to collections — or you could be sued for the debt.
- If the lender offers help, weigh your options: The lender may choose to offer temporary hardship assistance or loan restructuring. If there’s a debt restructuring proposal, it could take several forms or there may be different options to choose from, such as an adjusted interest rate or repayment term.
- Negotiate with the lender: You may be able to negotiate the terms of your new contract before accepting a debt restructuring offer. For example, you might try to negotiate a lower payment amount or get fees and accrued interest waived.
- Accept the new terms: If you agree with the new terms for your loan, you’ll need to formally accept and sign the agreement. You’ll then be obliged to follow through with the new agreement and continue paying down your debt.
What are some debt restructuring alternatives?
- Debt consolidation: With debt consolidation, you’ll take out a new loan or line of credit to pay off your current debts. In doing so, you’re replacing your old debt with a new debt, ideally with different terms like a lower interest rate. A longer repayment period would also lower your monthly payments in exchange for higher overall interest charges.
- Debt management plan: Rather than trying to negotiate a debt restructuring agreement with your lender directly, you could work with a nonprofit credit counseling organization. The counselor can negotiate with your creditors on your behalf, and may be able to arrange a debt management plan. Generally, these are available for unsecured debts such as credit cards, and the counselor may be able to negotiate lower interest rates, lower payments, waived fees and bring your past-due accounts current.
- Payment forbearance or deferment: Loan forbearance or deferment allows you to temporarily skip several payments without paying late fees or having your account be reported late to the credit bureaus. These could be good options if you experience a temporary setback, but don’t need or want to permanently change your loan.
- Chapter 7 bankruptcy: If you’re overwhelmed by debts and don’t think debt relief or restructuring will help, Chapter 7 bankruptcy might be a better option. If you qualify, you may be able to wipe out the eligible unsecured debts you include in the bankruptcy, helping you start anew and freeing up resources to pay down any remaining debt.