COVID-19The rest of the effects of the pandemic have created a population that is mired in economic crisis.With incomes falling and expenses skyrocketing, the once routine of paying loan EMIs has become an insurmountable challenge for a significant section of the Indian population.Families are on the brink of financial ruin.Recognizing the seriousness of the situation, the Reserve Bank of India (RBI) had come up with a loan restructuring scheme as a solution to save people from the current debts.But what is debt restructuring and what does it mean?Read more in detail

What is restructuring?

Loan restructuring is a service offered by banks to avoid the risk of defaulting on an existing loan. It suggests a way for borrowers facing financial challenges or lack of liquidity to renegotiate the terms of their loan and manage repayment in a better way. At times, when repayment becomes unmanageable, the borrowers themselves can start the process of restructuring. This may include restructuring an existing lender's loan or switching to a new lender, known as a 'balance transfer'.

Let's understand loan restructuring through an example:

Rahul, who had taken a personal loan of Rs 5 lakh a few years ago, was easily paying the EMI of Rs 12,000 from his fixed income.However, when the COVID-19 pandemic hit, Rahul's company slashed his salary by 40% as part of cost-cutting measures.

With his income falling drastically, Rahul realised that it would be challenging to continue paying the EMI of Rs 12,000. There is a possibility that he may default on loan repayment till he is saved by the loan restructuring scheme introduced by the RBI.

Rahul approached his lender and requested to reschedule the loan. After assessing his situation, the bank agreed to extend the tenure of the loan from 5 years to 7 years. With this arrangement, Rahul's monthly EMI has been reduced from Rs 12,000 to Rs 8,500, so that Rahul can manage his loan EMI even with less income.

In addition, the bank also allowed a part of Rahul's outstanding loan to be converted into a special loan at a lower interest rate, which reduced Rahul's overall financial burden.

With the loan restructuring, Rahul will be able to reconcile his loan repayments with the current financial situation. Instead of damaging his credit score, he can comfortably meet his liabilities with revised repayment terms.

This example shows how loan restructuring can help borrowers who are facing temporary financial difficulties. By rethinking loan terms, borrowers can avoid defaults and navigate challenging financial situations more effectively.

Sometimes loan restructuring can be initiated when the borrower is unable to manage his repayment. The borrower can either refinance the existing loan with the same lender or he can switch to another lender. This is commonly known as balance transfer.

How does debt restructuring work?

The primary objective of loan restructuring is to provide relief to the borrower and increase the chances of repayment to the lender. The rebuilding process usually goes as follows:

1. Loan Term Extension: This extends your total repayment over a longer period of time, resulting in a reduction in monthly payments.
2. Interest Rate Reduction: This reduces the overall amount of interest you pay over the life of the loan, making monthly payments more manageable.
3. Deferment of payments: You may be able to temporarily defer your loan payments altogether for a certain period of time.
4. Loan Principal Deduction: In some cases, the lender may even agree to waive a portion of the total amount you borrowed.

When to consider loan restructuring?

1. Delay in repayment: Not being able to repay on time
2. Automated payment is not able to pay the entire EMI on the credit card
3. Too many loans and therefore cash flow problems
4. Loans at higher interest rates
5. Loss of employment can lead to financial hardship
6. Multiple loans

Let's get acquainted with a general idea of how loan restructuring works:

1. Contact 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 for a solution.
2. Discuss your options: The lender will introduce you to the various loan restructuring options available and assess your eligibility.
3. Discuss Terms: This involves finding a solution that works for you and the lender. Be prepared to provide documentation to support your financial difficulties.
4. Formalize the Agreement: Once you've reached an agreement, the lender will provide you with a new loan agreement that outlines the revised terms.

Types of Restructuring

When faced with financial difficulties, borrowers can familiarize themselves with various options for rescheduling the loan so that they can better manage their repayments. The two primary types of loan restructuring are:

Loan modification

• Loan modification is a process in which the lender agrees to modify the terms of an existing loan agreement. This may include reducing the interest rate, extending the loan term, or adjusting the payment schedule.
• By lowering the interest rate, the borrower's monthly installments become more affordable, easing the financial burden.
• Extending the loan term extends the outstanding balance for a longer period of time, which results in smaller monthly payments.
• The lender may consider temporarily reducing or postponing payments for a certain period of time, giving the borrower a much-needed break during challenging times.
• Loan modifications aim to prevent defaults by rearranging the loan to align it with the borrower's current financial situation.

Debt settlement

In cases where the borrower is unable to repay the entire amount due, the lender may be ready for a debt settlement

Debt settlement involves the borrower receiving a lump sum payment that is less than the total amount owed.

This option is usually used when the borrower has exhausted all other repayment possibilities and faces imminent default.

The settlement amount is negotiated between the lender and the borrower, which is usually much lower than the actual outstanding amount.

While debt settlement can provide immediate relief, it can also have a negative impact on the borrower's credit score and their chances of getting a loan in the future.

It is important to note that loan restructuring may incur additional charges such as service fees or processing fees, which may be more burdensome for the financially stressed borrower. Also, loan rescheduling 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 assess each borrower's circumstances and may reject readjustment requests if they feel that the risk of default is too high or the borrower's financial situation is too precarious.