On all the credit sites on the net, debt restructuring is advertised as a panacea. One could save by lower interest rates and reduce the instalment burden, is for example regularly assured. Unfortunately, many of the information texts are not concrete enough. The inclined reader is not told what debt rescheduling is exactly, how it is carried out and what advantages and disadvantages are involved. This article fills the gaps.
Debt rescheduling involves replacing an existing debt with a new one. As a rule, this means that an old loan is paid off by a fresh loan. The hope here is that the interest rate on the new loan will be more favourable. Due to the lower costs, the borrower saves. In the search for the new loan, it is therefore essential to compare loans. This is the only way to really find the loan with the lowest interest rates and the savings fall as much as possible.
Debt rescheduling is also frequently sought in order to change the term of the loan and thus adjust the amount of the instalment to one’s own needs. As a rule, the instalment should be reduced. This means that the term is extended. This may become necessary, for example, if you change jobs. If the new job is paid less than the old one, the monthly charge may be too high.
The opposite direction is of course also possible but is rarely used: If the borrower finds a better-paid job, he or she can pay more and would like to repay the loan more quickly by paying higher instalments. This option is rarely used because almost all loans include the right to free unscheduled repayments at a rate to be determined by the lender. A rescheduling is therefore unnecessary and only makes sense if the interest rates are lower at the same time.
Step by step: How does debt restructuring work?
First of all, it is necessary to find out the exact remaining debt. Two things must be taken into account: firstly, it is guaranteed by law that any debt may be repaid at any time. The previous borrower may therefore not, for example, refuse to provide information on the amount of the remaining debt.
Secondly, however, the previous lender has the right to charge an early repayment fee. This is in fact a penalty fee for the lender losing interest gains because the loan is repaid early. The maximum amount of the early repayment fee is regulated by law for all instalment loans taken out since 1 July 2010. The only exception to this is real estate financing. In this case, the lenders may continue to set the early repayment fee themselves. They also have this right for other instalment loans taken out before the reference date.
Regarding the legal regulation: If the loan runs for more than one year, the compensation amounts to a maximum of one per cent of the remaining amount. If the remaining term is less than twelve months, the maximum amount is capped at 0.5 per cent of the outstanding amount. Of course, every lender is free to take a lower early repayment fee or waive it altogether. If the debt rescheduling takes place in-house, many lenders, for example, waive it as a gesture of goodwill. They are happy that the customer stays. Rescheduling with the previous lender can, therefore, be cheaper, even if the interest rate alone is somewhat higher than with another lender.
Ask for the current debt level
In order to determine the remaining debt including the compensation to be paid, it is useful to ask about the “remaining balance”. This term covers all costs to be paid if the loan is now repaid. In addition, the debtor should ask about the credit account and the purpose of the loan. Both information is required for debt restructuring.
The previous lender will send a written “offer” with the requested information. As a rule, this “offer” is limited until the next instalment is due. It, therefore, makes sense to initiate a rescheduling directly after an instalment payment. This way, the time span for replacing the old loan with a new loan is as long as possible.
Applying for the new loan
Most lenders already offer the possibility of debt rescheduling in the application form for the loan. The information requested by the old lender must be noted here. However, most lenders do not offer an earmarked loan for debt restructuring. You must use the unused personal loan. The name is somewhat misleading: “private” does not mean that the money comes from a private individual. It indicates that it is the private decision of the borrower what to do with the money.
Earmarked loans are only eligible for debt restructuring if the loan exchange takes place within earmarking. This sounds more complicated than it is: If a person has a car loan and wants to reschedule, he or she can use another car loan to do so. However, if several loans are to be rescheduled at once, only the personal loan is possible. This also applies if not only a rescheduling but also a loan increase is carried out. This means that the person takes up a higher amount than the remaining balance in order to gain financial leeway for another need.
Replacing the old debt
For legal reasons, the debt rescheduling must take place via the current account of the borrower. Only in this way can the debtor prove in doubt that he has fulfilled his obligation. He can also check whether the new lender has actually paid out a loan in the desired amount.
In principle, there are two models for paying off the old debt. Firstly, the debtor transfers the amount himself from his account. As a rule, he must then prove to the new lender within a certain period of time that he has fulfilled this obligation.
However, most lenders prefer to make the transfer to repay the existing loan themselves. This ensures that payment is actually made. If the borrower does not carry out the rescheduling contrary to the assurance, this means an immense legal effort for the lender. He wants to avoid this by instructing the money himself.
If the debt is rescheduled in-house, this is not a problem, as the lender has direct access to the bank account. In the case of debt rescheduling via an external financier, it is somewhat more problematic. Some banks, therefore, require, for example, that a current account be opened with them for the debt rescheduling. Other donors request a one-time account power of attorney. This means that they receive the one-time right to make a transfer in the name of the debtor.
Receiving proof of debt rescheduling
The previous donor is obliged to confirm in writing as soon as possible that the debt has been duly and completely paid off. As a rule, the corresponding letter will arrive within two weeks. If the confirmation has not arrived within four weeks, it can be requested. The bank statement with the transfer serves this purpose. In some cases, the new lender also requests a copy of the repayment confirmation. There have been and still are cases in which the debtors have had the transferred credit posted back. If a lender requests a copy of the redemption confirmation, he or she would like to exclude this.
For whom is debt restructuring suitable?
There are three groups of people for whom debt restructuring is suitable: firstly, borrowers with older loans. Loan interest rates have fallen significantly in recent years. This applies across all types of credit. Anyone who pays off a loan that is three years or older can therefore almost always save.
Secondly, people who want to pay a lower rate benefit. By rescheduling their debt, they can reduce the monthly discount over a new term. Especially for borrowers with a tight monthly budget, this point is likely to be the decisive factor for debt restructuring.
Thirdly, people who have several loans and therefore have to pay several instalments benefit. The existing debts can be combined in one instalment. As a result, the monthly budget is usually significantly eased.
What advantages does debt restructuring offer?
- Savings through lower interest rates
- Lower rates due to a longer term
- Faster loan repayment due to a shorter term
- Avoid over-indebtedness by combining several loans into a single loan
- Better auxiliary conditions with the new loan (e.g. instalment breaks, free unscheduled repayments, etc.)
- Positive effect on Experian, because a loan is noted as “fully repaid before time
What are the disadvantages of debt restructuring?
A debt rescheduling can have four major disadvantages. Firstly, the biggest problem is the cost. If you are not careful, you run the risk of paying more in the future. This also applies if the effective annual interest rate of the new loan is lower. A longer term can lead to higher interest costs. If the new loan runs for longer, interest must also be paid longer. The absolute sum can, therefore, be higher than if the previous loan had been repaid regularly. It is therefore important to calculate precisely whether the debt restructuring is really cheaper. Only those borrowers who are forced to reduce their monthly instalments because otherwise, they will no longer be able to meet other payment obligations should accept higher costs.
Secondly, an early repayment fee should be paid, which will result in higher costs. This will result in higher costs. It should therefore always be checked whether the previous bank would waive the penalty fee in the event of an in-house debt restructuring and whether the new loan would thus be cheaper than taking out a loan from an external lender.
Thirdly, a certain amount of bureaucracy is involved in debt rescheduling. The remaining balance must be requested and a new loan must be applied for. And fourthly, this must be done within a relatively short time window, as the debt rescheduling offer is limited in time. If this period expires, a new offer can be requested. But the entire bureaucratic effort starts all over again.
To sum up: Is debt restructuring always worthwhile?
No, debt restructuring is not always worthwhile. A certain goal must be achieved by exchanging the loans. There must be a significant saving, the monthly instalment should relax and/or several loans should be replaced at the same time. Ideally, the goals go hand in hand. One saves and pays a lower rate. If none of the goals is achieved, debt rescheduling does not make sense.
If only one of the goals is achieved, it is necessary to weigh up the options. If you pay a lower instalment but have to accept higher costs, you have to decide individually whether it makes sense. The same applies if there is a saving, but it is only small. Particularly in the case of short-term loans (less than a year), it is then necessary to consider whether it is worth the bureaucratic effort and a possibly higher rate.
Rescheduling is almost always worthwhile if there are several loans. The burden of several instalments is so much higher than one, so that combining the debt into a single loan is the right decision.