Loan Restructuring Vs. Loan Refinancing

Refinancing is a quicker process than restructuring because refinancing is easier to qualify for. Read more for further details!

16 Dec,2022 13:19 IST 13 Views
Loan Restructuring Vs. Loan Refinancing

Loans are often useful to pay for planned and unplanned expenses. Banks and non-bank lenders expect borrowers to return the debt according to the terms of the loan agreement. Repaying the loan on time is crucial in order to avail trouble-free credit in the future and to avoid any negative impact on the credit report, not to say the legal hassles one might face in case of a default.

However, during the loan tenor, some borrowers may face financial difficulties in repaying the monthly EMIs. To solve the problem, lenders often come up with loan structuring or loan refinancing. For most people, loan structuring and loan refinancing processes can be perplexing. So, it is important to clear up the ambiguity before making the final decision.

Consider an example. A business person takes a loan of Rs 2 crore at an interest rate of 10% per year for five years. During COVID-19 the business suffers a setback. The entrepreneur defaults on the loan and gets repeated reminders from lenders to pay off the dues. The person then negotiates with the lender for an extra two years to repay the loan. This process is called restructuring.

Now, consider that after a few months the entrepreneur comes across a new lender offering loans at a lower rate of 8%. He then chooses to apply with the new lender for a fresh contract to replace the previous loan. This is refinancing.

Loan Restructuring

Loan restructuring is a method used by individual borrowers and lenders to avoid defaulting on current debts by negotiating the loan terms. It can be done by:

• Reducing the loan EMI
• Extending the loan repayment tenure
• Altering the previously agreed upon interest rate

For borrowers facing financial hardships, loan restructuring is a much better alternative than going into insolvency. It is also a win-win situation for the lenders as it helps them to avoid all costs associated with bankruptcy or writing off the loan altogether. Lenders agree to restructure a loan only if they are convinced of the borrower’s repayment capability.

Loan Refinancing

A loan refinance occurs when the terms of an existing loan are revised for better terms than the previous one. It refers to the process of taking a new loan to clear off one or more outstanding loans. Refinancing helps to reduce the loan interest rate, to change the duration of the loan, and also to alter the nature of the interest from fixed to adjustable.

For debtors struggling to pay off their loans, refinancing can also be used to get a longer-term loan with lower monthly payments.

However, opting for loan refinance does not necessarily mean that the borrower is in financial distress. Often, individuals refinance their loans to pay them off quicker, though they may come with prepayment penalties. Also, for some loan products like mortgages and car loans, refinancing tends to come with slightly higher interest rates.

Differences Between Loan Restructuring and Loan Refinancing

Loan restructuring occurs in special circumstances when borrowers with compromised financial stability negotiate with the creditor to restructure and change the existing loan terms for some relaxation. The most apparent distinction between loan refinancing and loan restructuring is that loan refinancing creates a new loan contract.

The major points of difference between restructuring and refinancing are as follows:

Loan Restructuring Loan Refinancing
It is an affordable alternative of debt reorganisation for borrowers on the verge of bankruptcy or financial trouble. Loan refinancing can occur under normal circumstances and is not limited to managing a financial downturn.
It can negatively affect the credit report. Restructured loans are usually reported as “written off” or “restructured” categories. There is no impact on the credit report.
As is evident, loan restructuring lowers the credit score. Loan refinancing boosts the credit ratings because the old loan is paid off in full. There may be a temporary dip in the credit score because of the new loan but it increases once borrowers start repaying the new loan.
No new contract is formed, only the terms are changed. A new contract is formed and it may involve a new lender.
The option of restructuring is not available all the time. Comparatively, loan refinancing is easily available.

Conclusion

Fundamentally speaking, restructuring alters an ongoing loan to change the existing terms of a contract when it is challenging for borrowers to pay their loans on time. Most lenders give a heads-up to restructure a loan in order to recover the loan amount and help borrowers not to default on their loans.

On the other hand, the primary reason for refinancing a loan is to get a more affordable deal. In this process, the new loan comes with better credit terms and the takings from the new loan is used to pay off the existing loan.

Both loan restructuring and loan refinancing are credit instruments that can be useful to borrowers. Regardless of the type of loan, banks expect the borrower to oblige the loan terms and make timely payments of the debt.

Borrowers who face shortage of funds and are looking for a loan restructuring or loan refinancing can avail these from IIFL Finance. The benefits of IIFL Finance loans range from low-interest rates to flexible repayment terms. Also, it comes with minimal paperwork, quick approval, and a fully online process. To know more, log in to the website of IIFL Finance now.

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