May 24, 2017 – By Dan Rafter
Has your credit card debt spiraled out of control? Are you juggling payments to a long string of creditors, feeling like you’re never making a dent in the amount of debt you owe? Even worse, is this debt growing each month because of high interest rates?
Faced with this stress, you might be considering a debt-management strategy known as debt restructuring. It’s a form of debt management that’s not as well-known as debt consolidation, but one that might be an option for consumers whose debt has gotten so bad that they’re considering filing for bankruptcy.
But while debt restructuring might help you gain control over your debt, it could also leave you with a new loan that comes with a sky-high interest rate. You might end up paying far more than what you originally owed when you pay back this new loan.
What is Debt Restructuring?
American Consumer Credit Counseling, an Auburndale, Massachusetts-based non-profit, says that in a debt-restructuring arrangement, people who are struggling with credit card or other debt take out a new loan, using that loan to pay off what they owe their creditors. They then must repay their new loan – with interest, of course – by making regular monthly payments.
In an ideal world, the terms of the new loan will result in a lower monthly payment that these consumers can afford. Even better, the new loan should leave consumers with a lower number of monthly payments while reducing the amount of overall interest that they pay.
Credit counselors might even negotiate with creditors to reduce the total amount of debt that these consumers must pay back.
That, again, is the ideal. Unfortunately, debt restructuring doesn’t always work that way.
Possible Problem: A High Interest Rate
Katie Ross, education and development manager for American Consumer Credit Counseling, says that debt restructuring comes with a big potential pitfall, especially for consumers who have weaker credit scores.
Unfortunately, most consumers who need debt restructuring will almost certainly have lower credit. FICO® Scores fall when consumers have high amounts of credit card debt. They also tumble when consumers are late by 30 days or more when paying several types of bills, including credit card bills. Many people considering debt restructuring will likely have missed payments in their recent past.
Ross says that consumers with such damaged credit will struggle to qualify for a debt-restructuring loan with a low, or even moderate, interest rate. Instead, they’re often forced to take out new loans with interest rates that are far higher than market averages, which means they’ll end up paying back significantly more than what they originally owed, even if their payments every month are smaller with their new loan.
“Many consumers fail to shop around for the best terms, or they get so focused on lowering their monthly payment that they don’t realize that in the end they’ll actually be paying a lot more interest in time,” Ross says.
Many people, and some debt-management agencies, use debt restructuring and debt consolidation as interchangeable terms. But there are differences.
A key part of debt restructuring – and what usually sets it apart from debt consolidation – is the negotiation process. The company working with you to restructure your debt will negotiate with your creditors. The goal is to convince your creditors to eliminate some of your outstanding debt before you take out a new loan.
There is no guarantee that these negotiations will be successful. Creditors are usually more likely to agree to forgive at least some debt if consumers are in such bad financial shape that they’re considering filing for bankruptcy. Creditors would rather recover at least some of what is owed to them, something they might not be able to do if consumers instead file for bankruptcy.
Debt restructuring might be a better alternative to bankruptcy. If you file for either Chapter 7 or Chapter 13 bankruptcy, your FICO® Score will fall by possibly 150 points or more. A Chapter 13 bankruptcy, in which you agree to a repayment plan, will remain on your credit report for seven years. A Chapter 7 bankruptcy, in which most or all of your debts are forgiven, will remain on your credit report for 10 years.
Ross says that she encourages consumers to consider other types of debt-relief programs in addition to debt restructuring to avoid the fees and high interest rates that often come with this solution.
Ross says that the best solution is often a debt-management plan in which individuals or couples who are struggling with debt work with a credit counselor to evaluate their financial situation, create a new household budget and set aside money each month to help pay down their debt.
This type of solution is ideal because it doesn’t require consumers to take out a new loan that might come with higher interest rates.
“This helps consumers save money over the long-term, makes it possible for them to pay debt faster and helps them avoid an extreme option like bankruptcy,” Ross says.
Time to Change Habits
Chris Tillman, manager of home buying service Real Estate Problem Solver in Hawkinsville, Georgia, says that debt restructuring is like any other financial tool: Consumers who use it to get out of debt and stay out of it, while making their required payments on time, will benefit. Not only will they eliminate their debt, their new record of on-time payments will help improve their credit scores.
Those who use it as a short-term solution and then run up debt again, though, will gain little from it.
“Just like a wrench, gun, computer or butcher knife, it can cause trouble if used the wrong way,” Tillman said. “Debt is never a good thing to have as a consumer. But if there is a need for it, be ready to work that debt until it’s gone.”
Brett Anderson, president of Hudson, Wisconsin-based St. Croix Advisors, said that both debt consolidation and debt restructuring only work if consumers are willing to change their financial habits after they rework their debt.
For example, if consumers return to using credit cards to buy items they can’t afford, they’ll simply run up their debt again. The work involved in debt restructuring or consolidation, then, won’t have meant anything, Anderson says.
“It’s a great idea if you go one step further. If not, don’t bother unless you address your future spending habits and stick to a budget,” Anderson says.