The Pros and Cons of Debt Restructuring
Debt restructuring can be a helpful tool for getting your finances back on track, but it also comes with some downsides to consider. This article explores the key pros and cons to weigh when deciding if debt restructuring is right for your situation.
What is Debt Restructuring?
Debt restructuring simply means changing the terms of your existing debt to make it more manageable. This usually involves negotiating with creditors to get them to agree to reduce interest rates, lower monthly payments, waive fees, or allow more time to pay off the debt.There are a few main ways debt can be restructured:
- Debt consolidation – Combining multiple debts into one new loan with better terms
- Debt settlement – Getting creditors to agree to accept a lump sum payment that is less than what you owe
- Debt management plans – Working with a credit counseling agency to get reduced payments and interest rates
- Bankruptcy – Using bankruptcy court to eliminate or reduce debts you can’t pay
The Potential Pros
Here are some of the key potential pros of pursuing debt restructuring:
- Lower interest rates – Debt restructuring often involves negotiating a reduction in the interest rate you pay on your debts. This means more of your payments go toward principal rather than interest.
- Lower monthly payments – Creditors may agree to reduce your minimum monthly payment amount through settlement or consolidation. This helps free up cash flow.
- Consolidate multiple debts – Combining all debts into one can help simplify and centralize payments. One monthly payment is easier to manage.
- Avoid bankruptcy – For some, debt restructuring is a way to avoid filing for bankruptcy and damaging their credit long-term.
- Stop collection calls and lawsuits – Getting debts settled or consolidated can lead creditors to stop collections attempts and lawsuits.
- Reduce total amount owed – In the case of debt settlement, creditors may agree to forgive a portion of the principal balance owed.
- Tax benefits – Some forms of debt relief lead to tax deductions or even exclude canceled debt from taxable income.
- Prevent wage garnishment – Settling with creditors can stop them attempting to garnish wages or seize assets.
- Improve cash flow – The right debt solution may free up disposable income to save, invest, or spend on necessities.
- Peace of mind – Finally tackling problem debt can relieve significant stress and improve quality of life.
The Potential Cons
However, there are also some potential downsides and risks to weigh with debt restructuring:
- Credit score damage – All forms of debt restructuring can hurt your credit, sometimes severely. This can last for years.
- High fees – Debt consolidation loans and credit counseling plans often charge sizable fees for their services.
- Tax liabilities – While canceled debt can be tax-exempt in some cases, sometimes it counts as taxable income.
- Property loss – To settle secured debts, you may have to surrender collateral like your home or car.
- Paying back-taxes – Any taxable canceled debt may need to be reported as income, creating a tax payment liability.
- Future borrowing difficulties – Poor credit scores earned during debt relief make future borrowing more difficult and expensive.
- Emotional impact – The process can be emotionally draining and difficult for family relationships.
- Scams – Debt relief scams steal billions per year through upfront fees without providing services.
- Lawsuits from creditors – Debt settlement and bankruptcy sometimes spur creditors to file lawsuits to contest the process.
- Repossession – During debt restructuring, creditors may lose patience and attempt repossessing property used as collateral on loans.
As you can see, while debt restructuring can be extremely helpful for regaining financial stability, there are meaningful risks to consider regarding your credit, taxes, and relationships with creditors. Consulting an expert can help ensure you pursue the right debt solution for your unique situation.
When Does Debt Restructuring Make Sense?
So when might debt restructuring be the most appropriate strategy? Here are some signs it could help:
- You can no longer afford minimum monthly payments
- Interest charges make paying off debt feel impossible
- You have a major hardship like job loss or medical bills
- Your debt load prevents meeting other financial goals
- You have multiple accounts in collections
- Creditors are aggressively pursuing legal action
- Your credit is already damaged and prevents borrowing
On the other hand, those with relatively manageable debt able to make payments may be better served by paying it down aggressively without restructuring.
Your Debt Relief Options
If you decide debt restructuring fits your situation, here is an overview of potential options to explore:
Debt Management Plans
Debt management plans provided by non-profit credit counseling agencies can lower interest rates and consolidate debts into one payment. While these programs charge monthly fees, they help organize payments and lead to interest savings over time. They also provide education on improving financial habits.
- Pros – Lower interest, consolidated payments, avoid bankruptcy
- Cons – Monthly fees, credit score damage, no reduction in principal owed
Debt Consolidation Loans
Debt consolidation loans allow you to roll multiple debts into a single personal loan, often with a lower interest rate. This helps simplify payments and can lead to faster payoff. However, qualification usually requires decent credit scores and sufficient income.
- Pros – Lower interest, single payment, fixed payoff date
- Cons – Origination fees, collateral required, credit score requirements
Debt settlement involves negotiating with creditors to pay a lump sum payment that is less than the amount owed, with the rest forgiven. This requires discipline to save up enough to make the offer. There are also tax implications on canceled debt.
- Pros – Reduce principal owed, avoid bankruptcy, stop collections
- Cons – Upfront fees, taxes on canceled debt, credit damage
As a last resort, filing for bankruptcy protection in court provides more formal debt relief, often eliminating most unsecured debts entirely or allowing foreclosure and surrender of property to discharge secured debts. However, it comes with severe credit damage and tax implications in some chapters.
- Pros – Eliminate eligible debt, stop wage garnishment, asset seizure
- Cons – High legal fees, credit score harm, public records, limited future borrowing
While each option has pros and cons to weigh, exploring multiple debt relief solutions is key to finding the right approach. Consulting an attorney that specializes in debt can help navigate the specifics of state laws and your personal financial situation.
Getting Started with Debt Restructuring
If you want to explore debt restructuring, here are some things you can start doing right away:
- Review budgets and expenses – Detail all income sources and spending to understand cash flow and areas to cut back. Getting leaner can help make payments more affordable or save up for settlement offers.
- Prioritize debts – List all debts by interest rate, principal owed, collateral pledged, and other key factors. This helps strategize which to tackle first.
- Research options – Now that you know the major debt relief solutions, dive deeper into the specifics to learn which pathway may suit your situation best.
- Contact creditors – Before taking major action, call creditors directly to explain hardship and attempt to negotiate reduced payments or interest rates.
- Consult attorneys – Highly recommended to discuss specifics with lawyers specializing in debt resolution and understand legal rights and responsibilities.
- Avoid scams – Unfortunately the debt relief industry has many bad actors. Carefully research any companies and understand all services, guarantees, and fees in writing first.
- Consider alternatives – Other options beyond formal debt restructuring include taking side jobs, cutting expenses deeper, or selling assets to pay off debts.
The most important thing is taking that first step and starting the education process to equip yourself to make the smartest financial decisions. There are solutions available to resolve debt and work toward financial freedom.
Helpful Debt Relief Resources
For further reading on debt restructuring and financial hardship programs, check out these useful resources:
- National Debt Relief – Reddit threads discussing National Debt Relief specifically
- How to negotiate debt yourself – Redditor detailing process of DIY debt settlement
- Credit counseling pros and cons – Overview of credit counseling trade-offs
- Medical debt negotiation tips – Negotiating medical bills specifically
- Debt management scam risks – FTC guidance on avoiding debt relief scams
- Do you need to hire a debt settlement company? – Avvo article exploring DIY vs professional debt settlement
- What debt settlement companies can and can’t do – Overview of debt settlement firm regulations
- What debt collectors can and can’t do – Know your consumer rights regarding debt collectors
- Alternatives to bankruptcy – Nolo guide to options beyond bankruptcy filings