What Is Debt Restructuring?
Debt restructuring is a process used by companies, individuals, and even countries to avoid the risk of defaulting on their existing debts, such as by negotiating lower interest rates. Debt restructuring provides a less expensive alternative to bankruptcy when a debtor is in financial turmoil, and it can work to the benefit of both borrower and lender.
Key Takeaways:
- Debt restructuring is available to companies, individuals, and even countries.
- The debt restructuring process can reduce the interest rates on loans or extend the due dates for paying them back.
- A debt restructuring might include a debt-for-equity swap, in which creditors agree to cancel a portion or all of the outstanding debt in exchange for equity in the business.
- A nation seeking to restructure its debt might move the debt from the private sector to public sector institutions.
How Debt Restructuring Works
Some companies seek to restructure their debt when they are facing the prospect of bankruptcy. The debt restructuring process typically involves getting lenders to agree to reduce the interest rates on loans, extend the dates when the company’s liabilities are due to be paid, or both. These steps improve the company’s chances of paying back its obligations and staying in business. Creditors understand that they would receive even less should the company be forced into bankruptcy or liquidation.
Debt restructuring can be a win-win for both sides because the business avoids bankruptcy and the lenders typically receive more than they would have through a bankruptcy proceeding.
The process works much the same for individuals and for nations, although on vastly different scales.
Important
Individuals hoping to restructure their debts can hire a debt relief company to help in the negotiations. But they should make sure they're dealing with a reputable one, not a scam.
Types of Debt Restructuring
Debt restructuring for companies
Businesses have a number of tools at their disposal for restructuring their debts. One is a debt-for-equity swap. This occurs when creditors agree to cancel a portion, or all, of a company's outstanding debts in exchange for equity (part ownership) in the business. The swap is usually a preferred option when both the outstanding debt and the company's assets are significant and forcing the business to cease operations would be counterproductive. The creditors would rather take control of the distressed company, if that's necessary, as an ongoing concern.
A company seeking to restructure its debt might also renegotiate with its bondholders to "take a haircut"—meaning that a portion of the outstanding interest payments will be written off or a portion of the balance will not be repaid.
A company will often issue callable bonds to protect itself from a situation in which it can't make its interest payments. A bond with a callable feature can be redeemed early by the issuer in times of decreasing interest rates. This allows the issuer to restructure debt in the future because the existing debt can be replaced with new debt at a lower interest rate.
In rare cases, a company can issue income bonds that promise to repay the principal only without coupon or dividend payments.
Debt restructuring for countries
Countries can face default on their sovereign debt, and this has been the case throughout history. In modern times, some countries opt to restructure their debt with bondholders. This can mean moving the debt from the private sector to public sector institutions that might be better able to handle the impact of a country's default.
Sovereign bondholders may also have to take a haircut by agreeing to accept a reduced percentage of what they are owed, perhaps 25% of their bonds' full value. The maturity dates on bonds can also be extended, giving the government issuer more time to secure the funds it needs to repay its bondholders.
Unfortunately, this type of debt restructuring doesn't have much international oversight, even when restructuring efforts cross borders.
Debt restructuring for individuals
Individuals facing insolvency can try to renegotiate terms with their creditors and the tax authorities. For example, someone who is unable to keep making payments on a $250,000 mortgage might reach an agreement with the lending institution to reduce the mortgage to 75%, or $187,500 (75% x $250,000 = $187,500). In return, the lender might receive 40% of the house sale proceeds when it is sold by the mortgagor.
Individuals can attempt to negotiate on their own or with the help of a reputable debt relief company. This is an area that's rife with scams, so they should make sure they know whom they're involving. Investopedia publishes a regularly updated list of the best debt relief companies.
FAQs
Debt restructuring involves concessions by creditors that lower an insolvent firm's payments so that it may remain in business. Restructuring normally is accomplished in three ways: via an extension, a composition, or a debt-for-equity swap.
What are the different types of debt restructuring? ›
Types of debt restructuring
- Loan modification.
- Payment deferral.
- Extending the loan term.
- Adjusting the balance due.
- Waiving penalty fees that have already been added.
- Reducing the interest rate.
The debt restructuring process typically involves getting lenders to agree to reduce the interest rates on loans, extend the dates when the company's liabilities are due to be paid, or both. These steps improve the company's chances of paying back its obligations and staying in business.
How long does debt restructuring hurt your credit? ›
As with most other negative credit report entries, settled accounts stay on your credit reports for seven years.
What is an example of a restructured loan? ›
An example of a typical restructuring would be lengthening the due date for the principal payment on a debt contract, or modifying the frequencies of interest payments. Restructuring occurs mostly in special circ*mstances, where borrowers are deemed financially unstable and are unable to meet debt obligations.
What are the three types of restructuring strategies? ›
Types of Restructuring
Divestment: A company unwinds a division to operate more efficiently. Legal restructuring: A company or its departments change their legal entity, policies or procedures. Cost restructuring: A company consolidates to weather an economic downturn.
Is debt restructuring good or bad? ›
While debt restructuring can damage your credit, it may be preferable to default, bankruptcy and other solutions that can do even more harm. If you're thinking about using a debt consolidation loan or balance transfer card, check your credit score to see where you stand.
What are the disadvantages of loan restructuring? ›
What are the potential drawbacks of restructured loans? While debt restructuring provides short-term relief, it can have some disadvantages, such as: Increased overall debt due to extended loan terms or reduced interest rates, leading to higher interest payments over an extended period.
What qualifies as troubled debt restructuring? ›
More specifically, a TDR occurs when a bank, for economic or legal reasons related to a borrower's financial difficulties, grants a concession to the borrower that the bank would not otherwise consider. The process of determining whether or not a loan modification qualifies as a TDR can be complex.
What is the difference between consolidation and restructuring? ›
Debt consolidation and debt restructuring both have a place in managing debt. Debt consolidation is a strategy that combines your debts. You use a loan or a large credit card to pay off all your debts, then repay that single loan. On the other hand, debt restructuring is when you negotiate with your creditors.
Which Is Better: Paying in Full or Settling? It's better to pay off a debt in full than settle when possible. This will look better on your credit report and potentially help your score recover faster. Debt settlement is still a good option if you can't fully pay off your past-due debt.
What is the difference between debt review and debt restructuring? ›
Debt restructuring involves negotiating with credit providers on behalf of a consumer who is struggling to pay their debt commitments to a manageable monthly payment so that they end up paying off their debt. Debt restructuring is also known as debt review and is as per Section 86 of the National Credit Act.
What is the difference between debt restructuring and rescheduling? ›
Indeed, restructuring the terms of a loan does not guarantee that the borrower will honor the future repayments. Debt rescheduling represents a solution to the company's economic issues and it does not ensure the recovery of the company.
What are the three types of debt restructuring? ›
Restructuring normally is accomplished in three ways: via an extension, a composition, or a debt-for-equity swap. An extension occurs when creditors agree to lengthen the debtor firm's repayment period. Creditors often agree to suspend temporarily both interest and principal repayments.
What will happen if I restructure my loan? ›
Financial Relief: Restructuring can provide immediate relief by reducing monthly payments and making them more manageable. Avoiding Default: By restructuring, you can avoid defaulting on your loan, which can have severe financial and credit consequences.
What is an example of a restructuring process? ›
Examples include reducing debt, cutting operating costs, or realigning business operations with market demands. The primary objectives guide the steps and actions taken during restructuring. The reason for change also makes it easier to help employees understand why change is necessary.
What are the different types of restructuring in finance? ›
The different types of restructuring include legal restructuring, turnaround restructuring, cost restructuring, divestment, spin-off, repositioning restructuring, and mergers and acquisitions.
What are the three typical categories of restructuring costs? ›
Restructuring costs consist of three general categories: (1) asset write-downs, (2) accruals for severance and relocation costs, and (3) accruals of other restructuring- related costs.
What are the different types of debt consolidation? ›
Loan debt consolidation is when you take out a new loan to pay off multiple debts. Four types of debt are commonly consolidated: credit card debt, student loan debt, medical debt and high-interest personal loan debt. You may reduce the overall cost of repayment by securing better terms and interest.
What are the different organizational restructuring options? ›
Types of Organizational Restructuring
- Mergers and Acquisitions. This restructuring takes place in case of a merger or acquisition. ...
- Legal Restructuring. A restructuring as such takes place when the changes in a company pertain to legal norms. ...
- Financials. ...
- Repositioning. ...
- Cost-Reduction. ...
- Turnaround. ...
- Divestment. ...
- Spin-Off.
