Loan Restructuring Vs. Loan Refinancing
Two different terms, often considered doppelgangers of each other. This article will set the record straight so these two terms never leave you confused!
“I think I should apply for a loan” — find us an adult on the face of the earth who never had this thought. Countries, corporations, startups, you, me… From billions to a few thousand, we’ve all relied on a loan from financial institutions at various points in life when we were strapped for cash. Often, a loan is a savior that we don’t want, but one we absolutely need.
Despite loans being so ubiquitous, there are two ‘loan’ terms that still confuse most people: loan restructuring and loan refinancing. Everyone assumes they are the same thing, but they’re not. Let’s shed some light on both and help you understand them better.
What Is Loan Restructuring?
Let’s say you’ve got a loan, and things don’t go as planned with repayment. When in severe financial distress and inches away from defaulting, loan restructuring is the way to go. Often used as a last resort, it involves reorganizing debt by altering existing contract terms with the bank. These terms include repayment period, repayable amount, and the number of installments that were previously agreed upon.
Always available? The option to restructure a loan is not always available and its implementation varies on a case-by-case basis. This is true for anything used as a last resort.
When to opt for it? If you’re in financial duress that is tough to climb out of, do whatever it takes to restructure your loan. Request an increased loan repayment tenure, reduced loan EMI, or an option to alter the frequency of interest payments.
Are lenders cool with it? Surprisingly, yes. Lenders will analyze your financial status and once they realize that bankruptcy can’t be avoided, they’d be ready to restructure your loan. Lenders do this to avoid any costs associated with bankruptcy. Restructuring helps them collect their interest and creates a win-win situation for both parties.
What Is Loan Refinancing?
Well, it’s almost synonymous with getting a new loan on better terms. This new loan, which requires a new contract, comes with a host of advantages such as lower interest rates, lesser penalties, reduced late payment charges, and transaction costs. You’ve probably seen a few ‘top-up’ loan offers floating around in your inbox. Claim one of them and your loan has been refinanced!
Always available? Yes, to an extent. It’s used more liberally compared to loan restructuring and unlike it, the use of loan refinancing is not limited to tackling severe financial distress. It’s almost like a better offer for a responsible customer.
What is it used for? Loan refinancing can be used for a variety of goals, ranging from debt consolidation and interest rate reduction to freeing up cash balances. Also, if you’re a market whizz and sure the market is about to go volatile, avail loan refinancing, especially if you’ve signed up for a floating rate of interest. It gives you the option to secure a fixed rate and protects you from further interest rate fluctuations down the road.
Are lenders cool with it? Definitely. A bite at loan refinancing is your lender’s way of saying thanks for your flawless repayment history and excellent Credit Score. However, a certain fee or amount is charged when they sanction your loan refinance application. Factor in this fee and ensure the deal, including all these extra charges, is a favorable one.
Best time to get it? Experts sing in unison – refinance your loan within the first half of your repayment tenor as it saves on interest payments. It is because the initial phase of repayment term is when borrowers repay majority of the interest component, while the principal amount is pushed to the second half.
Additional Reading: Coping with Financial Stress: Do’s & Don’ts
That’s it. The terms, their definitions, essential caveats… We think we did a decent job covering them all. But that’s not the end, however. You gotta give us a chance to digress on our thing, which is Credit Score. So, let us give you an overview on how both loan refinancing and loan restructuring affects your Credit Score.
Based on our research, what baffled us the most is that restructured loans are usually reported under ‘settled’ or ‘written off’ categories. As a result of it, lenders think of it as willful defaulting, and it thus has a negative impact on the Credit Score. On the other hand, loan refinancing has a positive impact on the Credit Score as payment history indicates your original loan as paid off.
