March 3, 2020

Credit debt rescheduling guide – refinance loans

The debt restructuring aims to fundamentally reorganize loan liabilities. To this end, one or more borrowers’ loans are replaced by taking out a new and more advantageous loan.

If, for example, a borrower has made regular repayments on a car loan, an installment loan or on an overdraft facility with his bank, it may make sense to replace these three individual loans and merge them into a single loan. This restructuring of existing loan liabilities is known as debt restructuring. This is particularly interesting in times of low interest rates, since the debtor can reschedule more expensive loans at a particularly low interest rate and save a lot of credit costs compared to the original debt.

Debt restructuring advice

New loan or contract change as debt restructuring?

New loan or contract change as debt restructuring?

In principle, borrowers can also take out the new loan from a bank other than the previous one, if necessary. If certain notice periods are observed, the contractor is not contractually obliged to apply for the new loan from the credit institution (s) that have been granted the existing old loans.

If the borrower opts for a new lender, a completely new loan contract is concluded for the new loan to be taken out.

If, on the other hand, the borrower agrees to reschedule the debt with the bank that also granted the old loan, it is generally not necessary to conclude a new contract. Contractual debtors and contractual creditors remain identical, the existing credit contract will only be continued on the basis of changed conditions.

Under such conditions, therefore, only a change in the contract of the existing credit relationship takes place.

What are the benefits of debt restructuring?

What are the benefits of debt restructuring?

Reduction of borrowing costs and interest

The combination of several loan debts into one loan can initially lead to a noticeable reduction in the interest cost burden. If a new loan is taken out at more favorable interest rates, the savings effect for borrowers will be greater, the more redeemable old loans with a relatively higher interest rate are to be repaid.

This applies in particular to old loans without an interest adjustment clause, which were taken out by the borrower in periods of high interest rates. Such loans with fixed interest rates bind the borrower to the interest agreement even in the case of generally declining loan interest rates, so that the borrower can usually only get rid of this by early loan repayment. The debt rescheduling of such old loans can bring about a noticeable financial relief.

On the other hand, if the old loan is based on a variable interest rate, the situation is more favorable for borrowers. In this case, the loan interest rate follows the market development with the consequence that the variable contract interest rate participates in interest rate cuts on the capital market. As a rule, there is therefore no need for a restructuring of the existing loan liability at interest rates with the agreed sliding rate clauses.

Transparency and control

In addition to tangible cost advantages, debt restructuring offers borrowers the opportunity to manage and monitor their debt more sustainably. If different loan liabilities are paid off at the same time, borrowers sometimes run the risk of losing track of their debt management. If they are then in arrears with the payment of credit installments, the entire remaining credit debt may fall due. Such typical constellations often form the prelude to over-indebtedness of the borrower, from which he can no longer get rid without professional help.

Debt restructuring can help avoid such situations by relieving borrowers from having to meet a variety of payment dates. Instead, after rescheduling, he only has to make a single repayment on time.

The debt rescheduling also tightens the contractual relationships. Borrowers are faced with different types of contractual terms in the case of several loans. The conclusion of only one credit contract ensures legal certainty and an overview.

The borrower knows what he is up to and can adapt to the applicable contractual terms. In addition to bureaucratic relief, rescheduling can also help the borrower to be more predictable and, as a result, more reliable in planning.

New economic freedom

Successful debt restructuring can also open up the possibility for the borrower to use the newly gained financial freedom of movement for previously deferred arrangements. Depending on the amount of the savings potential realized with the debt rescheduling, special repayments on the new loan may also be considered, which lead to a faster extinction of the loan debt.

What are the disadvantages of debt restructuring?

What are the disadvantages of debt restructuring?

Processing and brokerage costs for new loans

For the new loan, processing fees and, if applicable, agency costs are incurred, which the borrower has to bear. These cost items should always be taken into account when the economics of a debt rescheduling are overestimated, because they reduce the surplus that would result from the expected interest savings.

Under certain conditions, debt rescheduling can be unprofitable and should be avoided. This is particularly the case if the term of the remaining loan (s) is only marginal. The borrower should then recalculate whether the interest income from the new loan actually exceeds the costs associated with taking out the loan. Conversely, rescheduling can be all the more rewarding the larger the amount of old credit and the longer the remaining term.

Processing costs for old loans

If the debt is rescheduled, the borrower suffers an additional financial loss due to the full retention of the processing fees paid for the old loan. In the event of early termination of the old loan, the borrower will not be reimbursed the processing fees pro rata (i.e. depending on the remaining credit term). This economic loss must also be taken into account when calculating the overall debt rescheduling.

Processing fee and prepayment penalty

The economic benefits of debt restructuring can also be questioned by paying early repayment penalties or a processing fee if the old loan is canceled early.

The prepayment penalty is charged by some banks if the borrower cancels the loan without adhering to the specified notice periods. The compensation claimed is then the loss of interest suffered by the bank as a result of the early termination. In their contractual terms, other banks waive early repayment penalties in the event of early loan termination. Instead, they charge the borrower a separate processing fee for processing the contract.

Residual debt insurance

If the old loan to be rescheduled is insured against residual debt, the borrower will be reimbursed, in the event of termination, pro rata payments made for the residual debt insurance for the unused remaining credit term. However, as with the cost of taking out a loan, it is also the case here that the insurer withholds the processing fees incurred and does not refund them.

On the other hand, it is not possible to take an existing residual debt insurance to secure the new loan. The residual debt insurances sold in cooperation with insurance companies bring banks considerable commission payments and therefore represent a profitable loan coupling product for them. The contractual terms of banks and insurers therefore rule out a transfer of the residual debt insurance as a rule. Borrowers seeking debt restructuring are therefore obliged to take out additional residual debt insurance for the new loan if the bank makes the loan dependent on it. In these cases, additional financial burdens threaten, because the residual debt insurance always leads to an increase in the cost of the loan.

Which loans can be rescheduled?

Which loans can be rescheduled?

The possibility of debt restructuring is fundamentally possible for all forms of credit. In particular, debt restructuring is therefore possible

  • Installment loan
  • Overdraft facility
  • Building loan

Debt installment loan

Liabilities from one or more installment loan contracts can be converted into a new loan so that the borrower only pays off on a loan debt. If, for example, payments are made for each mail order, car and additional purchase loan, the new loan can be used to repay all of the borrower’s loan liabilities.

The debt is rescheduled by early repayment of the existing old loans. As the explanations for early loan repayment on this website show, it is important to distinguish between loan contracts with a fixed interest rate and a variable interest rate (sliding interest rate).

The notice periods for loan contracts with fixed interest agreements are generally longer than for sliding rates. If the borrower does not meet the notice periods, it should be borne in mind that the bank may also charge a prepayment penalty or a special contract processing fee.

Debt overdraft facility

The overdraft facility (overdraft facility) can also be rescheduled. In such cases, the extraordinarily high interest burden due to the constant use of overdrafts makes rescheduling by taking out a cheaper interest-bearing loan worthwhile.

For the rest, borrowers can cancel the overdraft at any time, because it is not a term-based loan contract. Rather, the bank provides the borrower with a certain credit line without requiring collateral or taking out residual debt insurance. The bank pays interest accordingly if the borrower uses the overdraft facility. It is not uncommon for an overdraft to add up to 12% pa or more in interest.

  • More on this under: Overdraft facility versus installment loan

Debt construction finance

The rescheduling of construction loans can also make sense if the interest rate falls and a new loan can be concluded on better terms. However, a building loan is closed regularly with long agreed contract terms and a corresponding fixed interest period.

In the terms of the contract, early repayment and rescheduling of the construction loan before the expiry of the fixed interest period is therefore always excluded. In exceptional cases, however, early loan termination is also possible if the borrower has a legitimate interest in otherwise realizing the mortgage-encumbered property.

In such a case, however, a not inconsiderable prepayment penalty is payable, the amount of which depends on the remaining term, the agreed contract interest rate and the current interest rate.

  • More on this under: mortgage rescheduling

When does debt restructuring make sense?

When does debt restructuring make sense?

Calculate interest savings and calculate expenses

Debt restructuring through borrowing offers clear advantages for borrowers who want to bundle their liabilities and pay them off at lower interest rates. However, whether the debt restructuring is actually beneficial and the intended savings effects depends on several factors.

In principle, debt restructuring can only be promising if the general level of lending rates has dropped noticeably. The effective interest rate on the new loan must be significantly lower than the effective interest rate on the old loan to be rescheduled, because all the costs incurred for loan repayment and new borrowing must be counted against the possible interest relief.

The cost items to be taken into account also include residual debt insurance, insofar as it is a condition for taking up new funds. The borrower should only decide to do so if this total cost calculation can be expected to result in clear economic benefits from debt restructuring. However, debt restructuring can then be a suitable means of optimizing debt.

Debt overdraft facility

A debt rescheduling with an existing overdraft facility can be particularly useful and advisable, which is also used regularly. The overdraft facility was initially developed for bridging financial bottlenecks quickly, but in practice has long since taken on the function of a regular loan. The result is an interest charge that is constantly in the double-digit range.

Borrowers who keep their current account in negative territory should therefore always consider the possibility of rescheduling. With a low-interest installment loan, you can initially balance the overdrawn account. If financing needs arise again in the period that follows, borrowers can access the consumer installment loan and thus avoid the sometimes adventurously high overdraft interest.

Short remaining credit terms

A debt rescheduling can be more loss-making if the contractual residual credit term ends in the foreseeable future. Even if the level of lending interest has dropped sustainably, the interest income that can be achieved through debt rescheduling can usually no longer outweigh the cost disadvantages associated with borrowing in the short time that remains.

What is the best way for the borrower to do this?

What is the best way for the borrower to do this?

In conclusion, it can be stated that the decision for or against a debt rescheduling always depends on the special economic conditions of the credit situation. Therefore, only a clear assessment of this situation can answer the question of whether there is actually a need for debt restructuring in individual cases. The best way to develop a reliable assessment of the credit situation as a basis for decision-making is in four individual steps.

1. Debt overview plan

1. Debt overview plan

At the beginning there should be a complete review and recording of all loan liabilities. In the case of several loans, the compilation should show the following aspects individually

  • Loan type and loan amount
  • Amount of the monthly installment
  • respective loan interest rate (APR)
  • Remaining credit term
  • Cancelability
  • if applicable, prepayment penalty or contract processing fee
  • Residual debt insurance and possible proportional reimbursement value

In the case of several loans in particular, the borrower has to undergo time-consuming work to determine all the circumstances relevant to the decision. Ultimately, however, he can only make the right decision if he first gains clarity and an overview of his initial economic situation.

2. Comparison with alternative offers

2. Comparison with alternative offers

Based on this data, the borrower can compare the terms of his existing loans with other market offers. Particular attention should be paid to this

  • the APR
  • the processing and agency costs
  • the need for residual debt insurance

These points should be recorded separately. The borrower can now first compare the loan interest data (effective annual interest rate) of the competing products with the corresponding interest rates of their existing loans. From the outset, those offers can be disregarded if their effective annual interest rate is not significantly lower than that of his current loan liabilities.

3. Profitability analysis

3. Profitability analysis

The next step is to clarify whether the lower interest rate actually bears the costs of rescheduling. The borrower can access the data and figures he has collected and now calculates the interest rate advantage of possible loan alternatives against all the costs of taking out a new loan and repaying the old loan.

In particular, the costs of a residual debt insurance for the new loan must be taken into account if it is required to take out a loan. If, based on this calculation, it is clear that the interest rate advantage of the new loan will be offset by the expected total cost burden, the borrower should refrain from rescheduling.

4. Check the new lending requirements

4. Check the new lending requirements

On the other hand, if the performance audit reveals that rescheduling brings clear cost advantages, it is not advisable to rush to replace the old loans as long as it is not certain that the borrower also meets the personal credit requirements. Therefore, in a final step, the exact conditions under which the debt rescheduling loan can be taken out should be clarified.

Of particular importance is the creditworthiness of the borrower, which is routinely queried with every loan application. For borrowers, the basic rule is that experience shows that their creditworthiness can suffer if several loans are repaid. The borrower should therefore clarify precisely this point before a planned debt restructuring.

Use the low interest rate phase and save interest costs through cheap debt restructuring.

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