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The Pros and Cons of Debt Restructuring For Consumers

By Spodek Law Group | February 20, 2024

The Pros and Cons of Debt Restructuring for Consumers

Debt restructuring can provide much-needed relief for consumers struggling with high amounts of debt. However, it also comes with drawbacks and risks to consider. This article explores the key pros and cons of debt restructuring to help consumers make an informed decision.

What is Debt Restructuring?

Debt restructuring involves changing the terms of debt agreements to make repayment more manageable for the borrower. This usually means reducing interest rates, extending repayment periods, or reducing minimum payments. Lenders may agree to restructure debts through settlement, consolidation, or management programs.Common types of debt restructuring include:

  • Debt consolidation loans
  • Balance transfers to a lower-interest credit card
  • Debt management plans through a credit counseling agency
  • Debt settlement where creditors agree to reduced payoffs
  • Bankruptcy filing to eliminate or reduce debts under court supervision

The Pros of Debt Restructuring

There are several potential benefits that make debt restructuring an attractive option:

1. Lower Interest Rates

Restructuring often involves consolidating debts into a single loan with a lower interest rate. This reduces the total interest paid over time, saving money. For example, moving credit card balances with 20% APR to a consolidation loan with 5% APR cuts interest costs dramatically.

2. Lower Monthly Payments

Extending loan terms through restructuring means lower monthly payments. This helps free up cash flow to cover basic living expenses without falling further behind on debts. Many people seek temporary payment relief through restructuring programs.

3. Avoid Bankruptcy

For borrowers struggling with overwhelming debts, restructuring agreements with creditors can avoid the need for bankruptcy. This provides financial relief while avoiding the long-term damage of a bankruptcy filing.

4. Settling Debts for Less

In some cases, lenders will agree to settle debts for less than the full balance as part of a restructure. This provides immediate savings on debts consumers cannot reasonably pay off otherwise.

5. Stop Collection Activities

Restructuring and actively repaying debts can convince creditors to stop debt collection attempts. This provides immediate relief from the stress and frustration of continual creditor harassment.

The Cons of Debt Restructuring

While debt restructuring offers important benefits, there are also downsides to weigh:

1. Credit Score Damage

Any late payments associated with restructured debts can further damage credit scores. Missed payments may also violate restructure agreements. Consumers must carefully budget to avoid these outcomes.

2. Higher Total Repayment Costs

While interest rates may decrease, extending a loan term from 5 years to 7 years increases the total interest paid over the full repayment period. Borrowers should run the numbers to understand true restructure costs.

3. Tax Consequences

If lenders forgive portions of debt through a restructure, the cancelled debt may count as taxable income. Consumers can face unanticipated tax bills as a result.

4. Fees and Closing Costs

Just like taking out a new loan, restructuring often involves fees and closing costs. And if restructuring fails, late fees and default interest rates may rapidly escalate debts again. Consumers must budget appropriately to successfully repay under new terms.

5. Equity Loss

Restructuring programs may require borrowers to put up collateral like homes or cars. Defaulting on the revised agreements can then result in seizure of secured property, causing substantial wealth and equity loss.

Pros Cons
Lower Interest Rates Credit Score Damage
Lower Monthly Payments Higher Total Repayment Costs
Avoid Bankruptcy Tax Consequences
Settling Debts for Less Fees and Closing Costs
Stop Collection Activities Equity Loss

Key Considerations for Debt Restructuring

Consumers weighing debt restructuring options should keep several factors in mind:

  • Ability to meet new payment terms – Avoid further damage by only agreeing to what can realistically be repaid.
  • Upfront costs – Closing costs and fees can add up quickly and undermine savings.
  • Credit score impacts – Late payments will counteract some of the benefits of restructuring.
  • Tax implications – Make provisions for any tax bills from cancelled debt.
  • Alternative options – Compare the costs and benefits to other debt relief alternatives.

Getting professional advice is also highly recommended when exploring restructuring. Non-profit credit counseling provides this guidance at little or no cost.

Making an Informed Decision

Ultimately, the pros and cons of debt restructuring depend heavily on personal financial situations and repayment capabilities. There is no one-size-fits-all solution.Consumers struggling with unmanageable debts should carefully weigh all their relief options, arm themselves with information, and get expert guidance. An informed decision can lead to the best path back to financial stability.

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