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The Risks and Drawbacks Associated With Debt Restructuring

By Spodek Law Group | February 20, 2024




The Risks and Drawbacks of Debt Restructuring

Potential Damage to Credit Score

One major risk of debt restructuring is potential damage to your credit score. When you restructure debt, it shows up on your credit report and can lower your score anywhere from 60 to over 100 points. This can make it harder to qualify for loans, credit cards, mortgages, and more in the future.

The impact on your credit depends on specifics of the debt restructuring:

  • Settling debt for less than owed hurts more than re-aging accounts or changing payment terms
  • The more accounts included in restructuring, the bigger hit to credit
  • Amount of debt restructured versus credit limits plays a role too

Even with damage, your score can recover over time as you make on-time payments under the new restructured debt terms. But repairing credit takes time.

Fees and Fine Print

Debt restructuring often involves working with a credit counseling agency or debt settlement company. These services charge fees and have fine print to watch out for:

  • Upfront fees before settling any debts
  • Monthly service fees
  • Percentage charges on debt enrolled or settled
  • Potential for pricey extras like financial education

Fees can really add up. Make sure to vet any agency thoroughly and get fee details in writing upfront before signing.

Debt settlement in particular carries risk of high fees with no guarantees. Settlement firms make big promises to reduce debt owed. But there is no assurance creditors will accept settlement offers. You could pay thousands in fees while still owing original debt amounts.

Non-profit credit counseling limits fees but offers less flexibility in restructuring options. Do your homework to find the best fit.

Tax Implications

With certain types of debt restructuring, you may owe taxes on the amount of debt forgiven. For example:

  • Settling credit card debt for less than you owe may generate taxable income
  • Some loan modifications are not taxable but others might have tax impacts
  • Bankruptcy can discharge debt without tax consequences but be aware of risks

Work with a tax professional to understand potential tax costs. Plan for this in evaluating true savings from any debt relief.

Limited Flexibility

Once you enter into a debt management plan with a counseling agency, you have little flexibility to change terms. This commits you to making preset monthly payments over 3-5 years. You can’t easily speed up payoff or shift payments between accounts.

Debt settlement allows prioritizing certain debts but still locks you into a multi-year process. Weigh loss of flexibility against any savings.

Credit Freezes

As part of restructuring, many creditors will freeze accounts rather than closing them. This can:

  • Halt interest and late fees
  • Pause credit reporting
  • Block use of card without impacting credit line

This helps in the short-term. But long-term it reduces overall available credit. And it leaves accounts open to fraud/identity theft risks.

Frozen accounts also lack the consumer protections of closed accounts regarding debt collection. Be sure to get clarity from each creditor on freeze policies and protections.


Before pursuing debt restructuring, fully explore alternatives:

  • Direct negotiation with creditors
  • Non-profit credit counseling without formal debt management
  • Balance transfer credit cards
  • Personal loans with lower rates
  • Employer loan assistance programs

While not always easy, the risks and drawbacks may be less severe than with formal debt restructuring plans.

The Bottom Line

Debt restructuring often seems like a convenient quick fix. But the risks and drawbacks are real. Damage to credit scores, unexpected fees and taxes, loss of flexibility, account freezes, and more can quickly erase any benefits. Examine all options thoroughly and proceed with eyes wide open.













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