How to Restructure Your Loan: Understating Loan Restructuring

The devastating effects of the COVID-19 pandemic left a trail of financial turmoil in its wake. As incomes dwindled and expenses soared, the once-routine task of paying loan EMIs became an insurmountable challenge for a significant portion of the Indian population. Families found themselves teetering on the brink of financial ruin. Recognizing the gravity of the situation, the Reserve Bank of India (RBI) stepped in with a loan restructuring scheme – a solution to save people from defaulting on their current loans. But what exactly is loan restructuring, and what does it entail? We will uncover that in this blog.

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What is Loan restructuring?

Loan restructuring is a service offered by banks to avoid the risk of defaults on an existing loan. It provides a way for borrowers facing financial challenges or liquidity crunch to renegotiate the terms of their loan and make repayments more manageable. At times, borrowers themselves can initiate the restructuring process when they are unable to manage their repayments. This could involve reworking the loan with the existing lender or moving to a new lender, commonly known as a ‘balance transfer.’

Let’s understand loan restructuring with an example :

Rahul, who had taken out a personal loan of Rs. 5 lakh a few years ago. He was comfortably paying the monthly EMI of Rs. 12,000 with his steady income. However, when the COVID-19 pandemic hit, Rahul’s company implemented cost-cutting measures, and his salary was reduced by 40%.

With his income significantly reduced, Rahul found it challenging to continue paying the Rs. 12,000 EMI. He was at risk of defaulting on his loan repayments until he was saved by a loan restructuring scheme introduced by the RBI. 

Rahul approached his lender and requested to restructure his loan. After evaluating his situation, the bank agreed to extend the loan tenure from 5 years to 7 years. This adjustment reduced his monthly EMI from Rs. 12,000 to Rs. 8,500, making it more manageable with his reduced income.

Additionally, the bank also allowed Rahul to convert a portion of his outstanding loan into a separate loan with a lower interest rate, further reducing his overall financial burden.

Through loan restructuring, Rahul could align his loan repayments with his current financial situation. Instead of defaulting and damaging his credit score, he could comfortably meet his obligations with the revised repayment terms.

This example demonstrates how loan restructuring can assist borrowers facing temporary financial difficulties. By renegotiating the loan terms, borrowers can avoid defaults and navigate challenging financial circumstances more effectively.

At times the borrower himself can initiate loan restructuring when he is unable to manage his repayments. When the borrower initiates it could be reworking of the existing loan with the same lender or he may choose to move to another lender. This is commonly known as ‘balance transfer’.

How does Loan restructuring work?

The primary goal of loan restructuring is to provide relief to the borrower and increase the chances of repayment for the lender. Here’s how the process of loan restructuring typically happens:

1. Extending the loan term: This spreads out your total repayment over a longer period, resulting in lower monthly payments.
2. Reducing the interest rate: This lowers the total amount of interest you pay over the life of the loan, again making the monthly payments more manageable.
3. Deferring payments: You might be able to temporarily postpone your loan payments altogether for a set period.
4. Reducing the loan principal: In some cases, the lender might even agree to forgive a portion of the total amount you borrowed.

When to go for loan restructuring?

1. Delays in repayment: unable to repay on time
2. Defaults are not able to pay the total outstanding on the credit card or the whole EMI
3. Too many loans and hence cash flow issues
4. Earlier borrowings at higher interest rates
5. Loss of Employment which may cause financial distress
   Multiple Debts

Here’s a general idea of how the Loan restructuring works:

1. Reach out to your lender: If you’re struggling to make your loan payments, contact your lender as soon as possible. Explain your situation and your willingness to work with them on a solution.
2. Discuss your options: The lender will walk you through the different loan restructuring options available and assess your eligibility.
3. Negotiate the terms: This will involve finding a solution that works for both you and the lender. Be prepared to provide documentation to support your financial hardship.
4. Formalise the agreement: Once you’ve reached an agreement, the lender will provide you with a new loan agreement outlining the revised terms.

Types of loan restructuring?

When faced with financial difficulties, borrowers can explore various loan restructuring options to make their repayments more manageable. The two primary types of loan restructuring are:

Loan Modification

• A loan modification is a process in which the lender agrees to modify the terms of the existing loan agreement. This can involve reducing the interest rate, extending the loan tenure, or adjusting the payment schedule.
• By lowering the interest rate, the borrower’s monthly instalments become more affordable, easing the financial burden.
• Extending the loan tenure spreads the outstanding balance over a longer period, resulting in smaller monthly payments.
• Lenders may also consider temporarily reducing or deferring payments for a specific period, providing the borrower with a much-needed respite during challenging times.
• Loan modifications aim to prevent defaults by restructuring the loan to align with the borrower’s current financial situation.

Debt Settlement

• In cases where the borrower is unable to repay the entire outstanding amount, the lender may agree to a debt settlement.
• A debt settlement involves the lender accepting a lump sum payment that is lower than the total outstanding balance.
• This option is typically explored when the borrower has exhausted all other restructuring possibilities and is facing imminent default.
• The settlement amount is negotiated between the borrower and the lender, and it is usually significantly lower than the actual outstanding amount.
• While debt settlement may provide immediate relief, it can have a negative impact on the borrower’s credit score and future borrowing prospects.

It’s important to note that loan restructuring may come with additional charges, such as service fees or processing fees, which could further burden the financially stressed borrower. Additionally, loan restructuring may have an impact on the borrower’s credit score, as it can be interpreted as a sign of financial distress.

While loan restructuring can provide relief and prevent defaults, it is not a guaranteed solution for everyone. Lenders carefully evaluate each borrower’s circumstances and may reject restructuring requests if they deem the risk of default too high or the borrower’s financial situation too precarious.