Debt restructuring – what does that mean?
If you reschedule a loan, it means that you terminate the previous loan prematurely and take out a new one. The main reason for this approach is that customers expect better terms from the new loan.
Debt rescheduling is particularly useful if the new loan brings lower interest rates. This can be the case when the general interest rate level has dropped. However, there are also personal living circumstances that make it possible to get a cheaper loan. This is the case, for example, if your salary has increased so that you can now boast a higher credit rating. Even if there was a negative Credit Bureau entry at the time of building the house, which has since been deleted, this can result in you receiving a cheaper interest rate.
Benefit from low interest rates
Debt restructuring is currently more topical than ever. This is because interest rates are at historically low levels. Not only people who take out a new loan can benefit from this. Even people who have already received this can get a cheaper loan through debt restructuring.
The reason for the low interest rates lies in the monetary policy of the Best Bank. It seeks to boost the economy by increasing the amount of money in circulation. One way to do this is to lend cheap loans to banks.
Not only do banks and business customers benefit from this – private individuals also receive extremely cheap loans in this way. Therefore, it is very important for everyone who is currently repaying a loan to review the old contracts and compare them with new alternatives. The savings can be substantial.
The following calculation example shows how great the potential savings are. For example, if you took out a loan of $ 100,000 over a ten-year term with full repayment and an interest rate of 4 percent, you will have to pay a total of around $ 23,000 in interest. If an interest rate of 2.5 percent is now possible due to the low interest rates, the rates are otherwise only around 14,000 USD under the same conditions.
This calculation clearly shows that even with a relatively small loan amount for a house purchase, the saving potential is around 9,000 USD. If you have taken out a higher loan, you can save a lot more money. In addition, in many cases the difference between the current interest rate and the interest rate after debt restructuring is significantly higher than in our calculation example. This also provides even more opportunities to save money.
Note the prepayment penalty
The previous chapter described how high the savings potential is even if the interest rate is lowered slightly. Although this option seems very tempting, it is important to carefully review the terms of the old contract. In this case, banks almost always demand prepayment penalty.
In your original loan agreement, you agreed with the bank that your loan would be valid for a certain period. If you cancel this now, the bank will lose the business due to the interest accruing. For this reason, it collects the prepayment penalty, which is to be considered as compensation for the lost profit.
The amount of the prepayment penalty can vary from case to case. This depends primarily on the individual agreements that can be found in your loan agreement. The amount of the remaining loan and the remaining term are also important. It is therefore advisable to read the contract carefully first and to contact the bank or, if necessary, a lawyer if anything is unclear.
Legislators have created favorable conditions for loans with very long terms. If you took out the loan more than ten years ago, there may be an extraordinary right of termination without incurring early repayment penalty. In this case too, it may make sense to contact the bank directly or, if necessary, a lawyer.
The forward loan as an alternative to classic debt restructuring
If you want to benefit from the currently low interest rates, but do not want to terminate the loan contract prematurely due to high compensation, there is another option. This is called the forward loan.
You are already entering into a loan contract for the date on which your current contract expires. In doing so, the bank undertakes to grant you an interest rate that is already being set and which is roughly the current level.
However, the interest rate is usually slightly higher than for a loan that you take out immediately. However, this rate remains valid even if the interest rate should rise in the meantime. Therefore, you should only conclude such a contract if you assume that interest will rise significantly by the end of your contract.
This variant has the disadvantage that you still have to pay the high interest of your previous contract until the end of the term. In addition, the interest rate level is slightly higher than with an ordinary loan. However, you do not have to pay a prepayment penalty this way. This alternative is therefore particularly suitable for loans for which a very high value has been agreed.
When is debt restructuring worthwhile?
The most important question for all people who have to pay off a loan is certainly whether the debt restructuring is worthwhile for them personally. It should be clearly stated that this is not always the case. It is therefore important to always examine the individual case and answer this question individually.
First of all, it is important to check the terms of the previous contract. On the one hand, you have to consider how high the interest you have to pay with your previous contract. If you have difficulties with the calculation, an interest calculator on the Internet can also help you.
On the other hand, you have to take from your previous contract how much the prepayment penalty would be. If you have problems understanding the difficult wording of the contract or performing the corresponding calculations, it makes sense to make an appointment with your bank to clarify these questions.
In the last step you have to calculate how high the interest would be on a new loan. For this, it is necessary to obtain corresponding offers from the banks. A credit comparison can also be helpful.
When you have finally determined these values, you have to compare whether the interest on the new loan plus the prepayment penalty is cheaper than the interest on the old loan. If this is the case, the debt restructuring is worthwhile for you.
Debt restructuring step by step
At the end of the article, a small guide is now to be presented, which presents all the necessary steps for debt restructuring.
- Find out about the current loan offers. You can use comparison computers on the Internet, for example, which offer a lot of helpful information. If you find an interesting loan, you can get a specific offer. This way you can see early on whether you meet all the necessary conditions for the new loan.
- Find out about the amount of the prepayment penalty. You can find this in your loan agreement or inquire with a consultant at your bank.
- Calculate the difference between the interest on your previous contract and the cost of the new option plus the prepayment penalty incurred. It is only sensible to continue with the further steps if this calculation shows potential for savings.
- Also take into account all other conditions of the new contract. With regard to the possibility of special repayments, for example, these should be at least as good as with your previous loan.
- If you have decided to reschedule the debt, you must first conclude the follow-up financing contract and then terminate your existing contract.