Borrowers often find themselves struggling to meet repayment obligations when faced with a sudden financial crisis like job loss or illness. In such cases, loan restructuring acts as an effective tool to rehash the terms of your loan agreement. Renegotiating loan terms makes payments more manageable, while avoiding the need to default on the loan due to a compromised financial capacity. This article discusses the process of loan restructuring in detail, covering everything from what is restructuring of loans to the process of debt restructuring and its pros and cons.
What is Loan Restructuring?
Loan restructuring is a financial strategy used by businesses, individuals, and even governments to renegotiate loan terms and avoid defaulting on current debts. It is a process that allows the borrower to modify the terms of the loan agreement to make repayments more manageable. Debt restructuring is a common strategy used to manage loans when borrowers are faced with financial struggles like job loss and market downturns that make repayments difficult. According to loan restructuring guidelines, it can be done by reducing the loan EMI, extending the repayment term, or altering the previously agreed-upon interest rate. Restructuring loans offer a mutually beneficial solution to the debtor and creditor.
Different Ways of Loan Restructuring
The main goal of loan restructuring is to ease the pressure on the borrower. There are 3 main ways of restructuring a loan and we’ve listed them below:
Extending the Loan Tenure
Extending the loan repayment duration is a common way to restructure loans. This approach usually involves requesting a longer repayment duration. Increasing the repayment tenure for the loan automatically lowers the monthly obligations, making EMI payments more manageable.
Interest Rate Modification
Another common debt structuring strategy is renegotiating interest rates on the loan. Adjusting interest rates can significantly impact the cost of borrowing. If you have a good credit score and existing relationship with the lender, you can request lower rates of interest. Some lenders even allow borrowers to switch from fixed to floating rates.
Principal Repayment Restructuring
This debt restructuring strategy involves reducing the principal outstanding on the loan. It can also mean negotiating a grace period during which the borrowers need not make repayments.
Pros and Cons of Loan Restructuring
The decision to restructure your loan comes with its own set of advantages and disadvantages. Restructuring debt can offer financial relief by reducing the monthly payment burdens and making them more manageable, especially when you are dealing with a financial crisis. By adjusting your loan terms, you can avoid potentially defaulting on the loan and prevent a significant drop in your CIBIL score.
Despite these benefits, loan restructuring also comes with some disadvantages that must be considered before you adopt this strategy. Firstly, extending the repayment tenure on your loan might bring down your monthly EMIs in the short-term, but it will result in higher interest costs in the long-run. Secondly, restructuring loans can have a short-term impact on your CIBIL score. Since debt restructuring indicates financial difficulties, adopting this strategy will inevitably cause a temporary dip in your credit score.
RBI’s Loan Restructuring Guidelines
The Reserve Bank of India (RBI) issued loan restructuring guidelines for banks and other lending institutions, offering them a framework for restructuring loans given to individuals for personal consumption and enterprises for business needs. The restructuring scheme was introduced to help borrowers deal with the economic fallout from the Covid-19 pandemic. Let’s have a look at the schemes included under the loan restructuring guidelines:
- Loan Restructuring 1.0
The loan restructuring 1.0 framework was introduced on 6th August 2020, allowing lenders to restructure loans with rescheduling of payments, adjustment of interest rates, or granting moratoriums for various borrowers like individuals, small businesses, and corporates without downgrading asset classification. According to the loan restructuring guidelines of framework 1.0, MSMEs with an aggregate exposure of over RS. 25 Lakhs to the lending institution (as of March 2020) can be eligible for such restructuring. The loan resolution framework 1.0 required lenders to create a board-approved policy outlining objective parameters that will be applied when considering a restructuring plea.
- Loan Restructuring 2.0
The loan restructuring 2.0 framework was launched in May 2021 to further expand the scope of this support for borrowers suffering due to the second Covid-19 wave. According to the loan restructuring guidelines of this framework, borrowers had the option to either opt for a moratorium or request a suspension of their EMIs for a few months. They could also request for a reduction in EMIs payable to ensure continued and regular payments.
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Loan Restructuring Guidelines: How Does Loan Restructuring Happen
Now that you know the meaning of loan restructuring, let’s understand the steps included in this process:
Step 1: Assess your Financial Situation
If you are thinking of restructuring your loan, you must first start by assessing your current financial standing. If you are restructuring a business loan, you should assess your cash flow, outstanding loan dues, and working capital needs to get a clear idea about your fiscal standing and loan repayment capacity.
Step 2: Contact the Lender
Being proactive as a borrower is essential when it comes to debt management. If you are facing cash flow issues, contact your lender at the earliest. While lenders are not obliged to agree to your restructuring requests, reaching out early helps you avoid mounting dues.
Step 3: Consider the Restructuring Options
If the lender does agree to explore loan restructuring, they will lay down various options and loan restructuring guidelines. This could include adjusted interest rates or lengthier repayment tenures. Consider each option carefully to pick the right choice.
Step 4: Submit Documents
You may need to submit extra documents to prove financial distress to the lender. This may include the revenue statements of your business and other financial documents.
Step 5: Accept New Terms
Once the lender has verified the documents, they will offer you the modified loan terms. If you agree with the revised loan terms, sign the new agreement to effectively restructure your loan.
Does Loan Restructuring Affect Credit Scores?
Opting to restructure your loan impacts your credit score. When you seek to restructure your loan, you are essentially acknowledging a compromised repayment capacity. Your credit score will display a temporary dip since loan restructuring shows that you have not been able to comply with the original loan terms. Additionally, if you miss or delay payments before the restructuring process is completed, these instances are also recorded in your credit report resulting in a dip in your CIBIL score even after the loan is restructured.
A reduced credit score can limit your future borrowing capacity, reducing the maximum loan amount you can qualify for. Lenders can also apply stricter loan terms like higher interest rates if you have a history of loan restructuring. However, you can rebuild and boost your CIBIL score after the restructuring is completed successfully through steps like timely payments, minimised credit utilisation, limited credit enquiries, and vigilant credit report checks.
Conclusion
Loan restructuring is a prudent strategy for borrowers struggling to repay outstanding dues in the midst of a financial crisis. Restructuring debt can help you make EMIs more manageable, helping avoid defaults on the loan. However, to effectively adopt a loan restructuring strategy, you must understand the restructuring guidelines and process thoroughly. Additionally, you must also cognise the advantages and disadvantages of adopting this strategy since it can increase the overall cost of the loan and temporarily impact your credit score.
Frequently Asked Questions
1. What will happen if I restructure my loan?
If you restructure your loan, you can adjust the applicable loan terms. Loan restructuring could mean lower monthly payments making it easier for you to manage your finances. It could also mean negotiating lower interest rates which would lower your overall cost of borrowing.
2. What are the benefits of restructuring my loan?
Restructuring your business loan may be a wise choice when you are dealing with cash flow problems and low revenue. Restructuring readjusts your loan terms with a longer tenure or lower rates of interest to help make repayments more manageable and avoid unnecessary loan defaults.
3. Does restructuring debt impact my CIBIL score?
Yes. Restructuring loans lowers your credit score because it indicates that you are facing financial difficulties and cannot make repayments according to the original loan terms.
4. What are the disadvantages of restructuring a loan?
Loan restructuring may result in higher overall borrowing costs if you decide to extend the repayment duration. A longer repayment duration results in higher interest payments overtime. Additionally, a restructured loan will lower your CIBIL score, reducing your chances of securing future credit on favourable terms.
