For borrowers struggling to service their debts, debt restructuring can be a lifesaver. In debt restructuring, the creditor consents to changes in the terms of your debt agreement so that your debt becomes more affordable.
The debt restructuring process can be undertaken through a modification of your loan repayment period, lowering the interest rate, etc. Whether you are a corporate entity or an individual repaying debt, it will help to gain an understanding of how the debt restructuring process works and which restructuring method is best for you.
What is Debt Restructuring?
Debt restructuring is an option used by firms, individuals, and sometimes even sovereign nations to avoid defaulting on a debt. Debt restructuring can be negotiated with the creditor, for example, by agreeing to a lower interest rate. Debt restructuring works to the benefit of both the lender and the borrower. When the borrower is in financial trouble and is unable to meet debt obligations with the present terms, restructuring of debt is a less expensive alternative, for both parties, compared to the prospect of bankruptcy.
Debt restructuring serves several vital purposes:
- It enables the implementation of a time-bound and transparent debt restructuring plan to aid borrowers facing financial distress.
- Minimizes the losses for the lenders and shareholders.
- Enables firms in distress by helping them stay afloat in the best interests of all the stakeholders - the firm, the creditors, and the shareholders.
How does Debt Restructuring Work?
The steps that you would need to initiate, together with your creditor, in the debt restructuring process include:
- Contact the Lender. Debt restructuring is essentially the lender’s response to a borrower finding it difficult to service debt. It is best that you contact your creditor as soon as you realize that you will not be able to meet the debt repayment schedule. This is better for your credit score. If you wait for the lender to contact you, it will be to your disadvantage since the creditor will contact you only after you have missed your payments and accrued penalties. This is also applicable in the case of debt restructuring for individuals.
- Wait for a Response. The lender is not obliged to come to your help and may insist on the original loan terms. If you are unable to make the repayments or the payments are delayed, the lender will report it to the credit bureaus. In cases of long-pending repayments, your debt account could be sent to collections, or the lender may decide to sue you.
- Weigh the Alternatives. If the lender agrees to provide either interim assistance to tide over temporary financial difficulties or a debt restructuring plan - carefully weigh the alternatives. In either of the above alternatives, the lender could offer many options - assess the impact of each option on you or your business before arriving at a decision.
- Negotiate. Before agreeing to any new terms for debt repayment, negotiate your new contract to arrive at mutually agreeable terms.
- Finalize New Terms. Once the new terms have been agreed upon, formally sign the revised agreement with the revised terms. The revised terms then become binding on you for debt repayment.
Available Methods for Debt Restructuring
The various alternatives available for implementing the debt restructuring plan include:
- Debt-for-Equity Swap. This is primarily meant for companies. In this debt restructuring process, lenders agree to liquidate a portion or all of the debt owed in exchange for equity/stake in the firm. This is a good option when the firm has significant assets and a large balance sheet, and it would be counterproductive to force the firm to shut down. It would instead benefit the lenders to take part ownership and control of the firm as a going concern.
- Bondholder Haircut. A business looking to restructure its debt can negotiate with its bondholders to agree to a ‘haircut’. A haircut implies that either a portion of the interest payments due will be written off or it will be agreed that the firm will not repay a portion of the balance.
- Renegotiating the Terms for Repayment. Another alternative that a distressed firm can consider is to renegotiate repayment terms. This could be through a reduction of the interest rate, waiving off some portion of the outstanding loans, or extending the repayment period.
- Debt Consolidation. In this method, you will be required to secure a new line of credit or a debt restructuring loan to clear your existing debts. The debt restructuring loan will usually have more favorable terms, such as a reduced interest rate.
- Payment Deferment. A debt restructuring plan through loan forbearance or payment deferment enables you to temporarily miss scheduled payments without having to pay a late fee or be reported to the credit rating agencies/bureaus. This is a good option in the case of debt restructuring for individuals. This is especially useful if you are not looking to change your loan repayment terms permanently but are only looking to tide over a short-term setback.
Benefits of Debt Restructuring
Thechief purpose of undertaking debt restructuring is to save and sustain the business. It offers additional benefits for businesses and also allows debt restructuring for individuals.
The benefits of debt restructuring include:
- Either through deferment, reduction in instalments, or reduction in the interest rate, debt restructuring provides you with immediate cash for investments in future business plans.
- Legal protection for the business from creditors.
- Legal protection for the assets of the firm.
- Helps keep the company running as a going concern.
- Creditors realize better recovery compared to the firm going bankrupt. In the case of individual borrowers, a debt restructuring personal loan helps creditors achieve superior outcomes.
Downsides of Debt Restructuring
- Reduced recovery due to lowered interest payments and extended schedule.
- The creditor’s balance sheet may be negatively affected by write-offs.
- Even after debt restructuring, the business may fail and be unable to clear the debt.
When managed well, debt restructuring can prove to be a win-win for both - the creditors and the borrowers. It can prove to be especially useful for startups and small businesses that are in the process of scaling up and growing the business.
Individuals faced with the prospect of insolvency can try and negotiate a debt restructuring personal loan with their creditors. Individuals can negotiate favorable terms personally or use the service of a reliable debt relief company.
Are you looking for funds for a debt restructuring loan and are falling short of your requirement? You can choose Personal Loan Restructuring from Tata Capital.