Is refinancing the same as restructuring?

Nikka Sulton

Is refinancing the same as restructuring?

Is refinancing the same as restructuring? Refinancing and restructuring may seem similar, but they serve distinct purposes. It’s a common misconception to use these terms interchangeably.

In essence, refinancing involves securing a new loan contract with improved terms to repay an existing one.

On the other hand, debt restructuring is a more comprehensive process that involves changing the terms of existing debt, often in situations where financial distress or insolvency is a concern.

Difference between Restructuring and Refinancing

Restructuring

Debt restructuring is a process used when borrowers face severe financial distress, making it challenging to meet their loan obligations. It typically involves modifying an existing contract and differs from debt refinancing, which entails starting a new contract.

Restructuring usually occurs when borrowers can’t fulfill their debt obligations, and it’s considered a last-resort strategy due to its potential negative impact on credit scores. In this process, the borrowing party negotiates with creditors to find a mutually beneficial solution.

Lenders prefer avoiding borrower defaults, as bankruptcy costs can be substantial. In most cases, lenders are willing to negotiate, potentially extending payment dates, waiving late fees, adjusting payment frequencies, or modifying coupon payment amounts.

Can loan restructuring affect credit scores?

Restructuring certainly has a detrimental effect on your credit score, and as a result, it’s strongly advised as a measure of last resort when all other avenues have been exhausted.

Nevertheless, it’s worth noting that there was a unique initiative introduced by the Reserve Bank of India (RBI) in response to the Covid-19 pandemic. This groundbreaking program encompassed personal and corporate loans, offering a one-time loan restructuring option. The primary objective behind this initiative was to provide financial relief to the numerous individuals and businesses in India who had been severely impacted by the economic repercussions of the pandemic.

This initiative brought substantial relief to borrowers and lenders alike. What set it apart was the fact that the restructuring process did not automatically lead to the classification of these accounts as non-performing assets. This flexibility was a significant boon during these challenging times. However, it’s essential to be aware that this opportunity was time-bound, available only until the conclusion of 2020, and had to be initiated within 90 days of seeking this option. It exemplified the adaptability of financial institutions in addressing the unique financial challenges posed by the pandemic.

What happens in loan restructuring?

Loan restructuring involves a collaborative negotiation between the lender and the borrower, aiming to revise the terms of an existing loan agreement. Open communication with your lender is a prudent step if you find yourself unable to meet your loan obligations, perhaps due to unforeseen circumstances like job loss. Informing your lender about your financial challenges can work in your favor, as they may show understanding and flexibility in response to your situation.

From the lender’s perspective, it’s important to recognize that no financial institution wants their borrowers to default on their loans. Lenders often prefer to work with borrowers who are facing difficulties rather than having them declare bankruptcy, a situation where the lender might not recover the loan amount in full. As a result, many lenders are willing to engage in discussions with borrowers who are struggling, potentially leading to loan restructuring. This can involve various adjustments, such as extending the repayment period, waiving late fees, or modifying the frequency of interest payments, all with the aim of finding a solution that benefits both parties.

Banks are willing to restructure loans if

It allows them to recover their debts
Banks have confidence in the intent and capability of the borrower

Refinancing

Debt refinancing is a method of reorganizing debt used by borrowers looking to replace their existing loans with more favorable terms to settle their previous obligations. It involves applying for a new loan with better terms to pay off the prior debt.

Compared to restructuring, refinancing is a more straightforward and faster process with easier terms and conditions. Moreover, it has a positive impact on the borrower’s credit score, as the payment history reflects the original loan as being paid off.

There are various reasons for choosing refinancing, such as debt consolidation, reducing interest rates, altering loan structures, and freeing up cash balances. Borrowers with high credit scores can particularly benefit from refinancing by securing more favorable contract terms with lower interest rates.

Is refinancing a good idea?

Refinancing serves a multitude of purposes, each aimed at improving a borrower’s financial situation. These purposes may include reducing the interest rates on existing loans, consolidating multiple loans into a single, more manageable one, restructuring the terms of a loan, or alleviating the overall burden of debt. Borrowers with strong credit scores stand to gain the most from refinancing, as they are in a favorable position to secure more advantageous contract terms and lower interest rates.

Common motivations for refinancing include:

Interest Rate Benefits: Seeking financial advantage by obtaining loans with more favorable interest rates.
Extended Repayment Tenure: Opting for a longer repayment period to make monthly installments more manageable.
Access to Additional Funds: Utilizing the opportunity to borrow extra funds beyond the original loan amount.
Improved Services and Features: Switching to a new lender to enjoy enhanced services and features.
Cost Reduction: Reducing the overall cost of the loan to ease the financial burden.

Restructuring	Refinancing
Definition
Restructuring of debt is a process of debt reorganisation which is used specifically when a borrower is under major financial distress because of which they are not able to repay their loans in a timely manner.	Refinancing of Debt is a process of debt reorganisation which is used when a borrower wants to leverage their newly obtained loans with much better terms so that they can clear their previous loan.
Contract
Debt restructuring mainly refers to the alteration of an already existing contract.	Debt refinancing mainly refers to starting with a new piece of contract.
Circumstances
Restructuring of debt occurs under special circumstances.	Refinancing of debt occurs under normal circumstances.

FAQs – Is Loan Restructuring Different from Loan Refinancing

Understanding Loan Restructuring – Loan restructuring involves altering the terms of an existing loan through an agreement between the lender and the borrower.
Extending Loan Tenure through Refinancing – Certainly. One can opt for refinancing to extend the loan tenure, among other reasons.
The Core Goal of Loan Restructuring – The primary objective of loan restructuring is to mitigate the risk of loan default.
Eligible Loans under RBI’s Restructure Framework – Under the Restructure Framework introduced by RBI in response to the COVID-19 pandemic, personal loans, home loans, car loans, education loans, and more are eligible for restructuring.
Impact of Refinancing on Credit Reports – Refinancing does not leave an adverse impact on the borrower’s credit report.