Debt Restructuring: Pros and Cons

Debt restructuring benefits and drawbacks

If you find yourself drowning in debt and unable to come up with a repayment plan on your own, you might consider debt restructuring. This is a broad term for the process of reaching out to your creditors in an attempt to secure more favorable terms, allowing you to catch up and eventually pay off your debt.

Popular restructuring options include securing a lower interest rate or extended repayment periods, or a creditor reducing the balance of your debt by forgiving part of it. The best option depends on the specifics of your situation.

Who should consider debt restructuring?

Good candidates for debt restructuring are people who have some ability to pay down debt, are not in bankruptcy and are looking to avoid it, have stable income and are not involved in litigation with creditors.

Debt restructuring may not be the best option for a debtor who has little to no income, is facing lawsuits or garnishments from creditors and would benefit more from the protections bankruptcy affords (such as no longer being hassled by debtors).

Key advantages of debt restructuring

There are numerous advantages to debt restructuring, all of which are geared toward making your debt more manageable. Possible advantages include the following:

• A longer repayment period
• Lower interest rates
• Forgiveness for a portion of your debt 

Key drawbacks of debt restructuring

Despite the pros, you’ll want to consider some potential cons before contacting your creditors about restructuring your debt.

• You could end up paying more in the long run (see below for an example).
• Your credit score could be negatively impacted.
• Forgiven debt above $600 is considered taxable income.

Debt restructuring can certainly help your financial situation in the short term, but it’s important to note that common changes creditors make to your debt can actually cause you to pay more in the long run. Consider the following example:

• Original loan: For a $50,000 loan at 5% interest for a period of five years, your monthly payment will be $944, and you’ll pay $6,614 in interest over the life of the loan.
• Restructured loan: Extending this same loan for five more years for a total of 10 years lowers your monthly payment to $530, but you’ll pay $13,649 in interest over the life of the loan.

Debt restructuring options and outcomes

In this section, we examine the most common types of debt restructuring options you might consider if you’re facing financial hardship.

Interest rate reduction

Requesting a reduction to the interest rate on your credit account is a way to pay down debt faster without affecting your credit score. Often, this only requires a call to your credit card’s customer service line. If you’re approved, the change can occur right away.

If you’re still able to secure low interest rates, you may use that as leverage when you call, saying that you’ll move your debt to another creditor who’s offered a lower rate. If your request is approved, paying the same amount each month can help reduce your debt more quickly.

Interest rate reduction is best for borrowers who are still able to pay their debts but would like a small boost to help pay it off faster. It may be a good first option if you’re facing hardship as well.

Repayment period extension

Extending the repayment period can drastically reduce your monthly payment obligation. If you’re facing an immediate financial hardship and you’re solely focused on reducing the amount of money you put toward your debt each month, a repayment period extension may be a solid option.

Temporary payment reduction or halt

In more severe cases of financial hardship, you may request that your creditors put a temporary halt on your monthly payments. This action could have an impact on your credit score, as it’s an obvious sign of financial distress. But it’s better than falling behind on payments or declaring bankruptcy.

Debt forgiveness

Perhaps the most extreme form of debt restructuring is debt forgiveness. This type of debt help involves asking your creditors to reduce your debt balance, forgiving a portion of the outstanding debt. Often, creditors won’t do this unless you’re already seriously delinquent on payments. Debt forgiveness will have a negative impact on your credit, though it’s impossible to state exactly how much your credit score might drop.

Debt restructuring vs. debt consolidation

Debt restructuring and debt consolidation are two different debt relief options, both of which can help you get out of debt quicker.

You can think of debt restructuring as a modification to your debt, while consolidation involves moving your debt from multiple accounts to one single, larger account so you direct all debt payments to one place. While restructuring seeks better terms for each credit account, consolidation moves as much debt as possible to a single account.

If you’re able to make payments but you feel overwhelmed managing all the credit accounts you have, debt consolidation might be a good option for you. It can help you save on interest payments, too, since your monthly payment will be subject to only one interest rate instead of many.

If you’re experiencing financial difficulty, debt restructuring can help. A lower monthly payment or interest rate can help keep more money in your pocket, allowing you to weather a temporary financial setback. Using this approach can also prevent you from taking on more debt.

» RELATED: Debt settlement pros and cons

Debt restructuring’s impact on credit

Some types of debt restructuring have little to no effect on your credit if you modify before you fall behind and miss payments. Options such as lowered interest rates can be used to score better terms on your debt and aren't always a sign of financial distress.

Other types of debt restructuring, such as debt forgiveness or temporary payment pause, can have a larger impact on your credit. The exact impact depends on your overall credit history and other factors such as your credit score, any delinquencies or missed payments, and prior bankruptcies.

If you’re considering restructuring your credit account, it’s a good idea to ask how the creditor will report the restructure to the credit bureaus. Below are some common reports:

• Paid as agreed
• Modified loan
• Account in a hardship program
• Current after modification
• Settled for less than the full balance
• Delinquent
• Charged off
• Included in bankruptcy

In many cases, debt restructuring can be a better alternative than filing for bankruptcy if your debt has become difficult to manage and you’re falling behind on payments. Most creditors will consider requests for modifications such as a lower interest rate or a payment pause or extension. While that could mean a minor negative impact to your credit now, it could be better than slipping further into debt.

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