Taking a loan helps decrease the current financial burden. The option to repay the loan with equated monthly instalments (EMIs) makes it easier for people to borrow a large sum of money to meet their immediate financial obligations.
However, sometimes, it becomes challenging to meet the debt obligations due to unavoidable circumstances. Companies and individuals can both face such a situation. Loan refinancing and a complete restructure of the loan are two possible solutions that can help borrowers change the terms of repayments whether or not they are in financial distress.
Though these two terms are often used interchangeably, they are distinct processes that can be used in different circumstances. Let’s explore what each term means and how they differ.
What is meant by the restructuring of loans?
Fundamentally, restructuring a loan means making changes to an existing loan so that the borrower is in a better position to meet the debt obligations. Here, the borrower needs to discuss with the lender and negotiate the changes in the credit terms. This could mean increasing the tenure of the loan to reduce the financial burden every month or even changing the frequencies of interest payments.
Lenders tend to comply with loan restructuring because they wouldn’t want the borrowers to default on their payments entirely. Additionally, loan restructuring will be a hassle-free procedure for both parties rather than filing for bankruptcy. Most banks and financial institutions would prefer to agree to restructure a loanbecause a default will also increase the volume of their non-performing assets.
However, the credit scores of the borrowers get negatively affected when they restructure a loan. This is also primarily why loan restructuring is often considered a last resort. Individuals can also restructure home loans when they encounter situations that affect their financial stability, like a lay-off or a loss in the business.
Relaxation on one-time restructure of loans
The Reserve Bank of India (RBI) announced a relaxation for those who wish to restructure their loans once because their financial stability was affected by the Covid-19 pandemic. Borrowers could now restructure home or corporate loans without affecting their credit score. Those interested had to complete their structure within 90 days of implementation. This option was only available until the end of the time period as stipulated by RBI, which was the end of 2020 for the first time, and September 30, 2021, when the scheme was relaunched due to the second wave of the pandemic. Such a restructure is applicable only on loans up to Rs. 25 crores and if the borrower has not previously opted for restructuring. To be eligible for this scheme, the borrower should be a standard borrower in the books of the bank or financial institution, which means they should never be a non-performing asset.
What is Loan Refinancing?
The most apparent distinction between loan refinancing vs loan restructuring is that loan refinancinginvolvesthe creation of a new contract. In contrast, loan restructuring changes the terms of the existing contract.
Opting for loan refinancing doesn’t necessarily involve the borrower's financial distress. The availability of better credit terms from someone else could be the reason why the borrower opts for loan refinancing.
However, even in loan refinancing, the debt obligation of the borrower is reduced. Typically, the proceeds from the new loan are used to pay off the existing loan, and the new loan comes with better credit terms like smaller EMIs and better rates of interest.
Further, another distinction between loan refinancing vs loan restructuringis that loan refinancing increases the credit score of the borrower. Better credit terms are only offered to borrowers if they have a good track record of meeting their financial obligations. The credit scores increase primarily because the old loan was paid off in full, which boosts the credit ratings.
Here are some of the situations where loan refinancing will help the borrower
Lower rates of interest or a shift from a floating rate of interest to a fixed rate of interest when the market is volatile.
Consolidating different loans and creating a single loan for more manageable repayment and lesser charges.
To borrow a slightly additional amount without taking an additional loan.
To enjoy better features offered by the new lender, which could include more liberal late payment charges, fewer penalties, and lesser transaction costs.
Exploring options for loan refinancing before the need for a loan restructuring arises is a smart choice for the borrower.
This table clearly defines loan refinancing vs loan restructuring:
Point of difference
Loan Refinancing
Restructure of a loan
Credit Report
Credit scores increase with old loans reflected as repaid and new loans appearing as due.
Negative Affected with the same loan appearing as ‘restructured’.
Contract
The new contract is formed and may involve a new lender as well.
The contract remains the same, but the terms are changed.
Circumstances for opting for this option
Typically when the borrower wants better credit terms.
When the borrower needs to change the credit terms to avoid defaulting.
Creditors Stance
Securing a favourable contract is much easier based on past credit repayment history.
Negotiation is required and should be initiated by the borrower.
Parting Thoughts
Both loan refinancing and loan restructuring offer better credit terms to the borrower. However, the circumstances under which they are opted for differ immensely. Planning the fulfilment of the debt obligations is the most important aspect of being a responsible borrower. However, there are always solutions to opt for to get out of unforeseeable situations.
Borrowers who are short of funds and wish to restructure their home loan, corporate or even opt for attractive refinancing options can do so seamlessly from Tata Capital. With loan restructuring plans that will understand the circumstances of the borrower and support them, Tata Capital will cover the financial needs of their customers every step of the way as they grow. In case you are short of funds, avail for Home Loan Restructuring from Tata Capital.
30 August 2022
5 mins read
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