What is the best option between restructuring or refinancing debts? Before answering that, you should understand why those concepts have gained some notoriety in these times of economic slowdown. Let us start by saying that most companies spend more money than what they earn. Really: not much of them take the time to make a spending plan and a debt budget with the money they get each month. Particularly in times of crisis, very few gather social security savings that they can use in case of losing their jobs. Sadly, a large number of entrepreneurs fail in their first attempts to create new businesses. For these reasons, over-indebtedness, the overuse of bank loans, and not being able to pay debts becomes a fairly frequent situation.
Several companies (especially the small ones,) operate on what they earn on a day-to-day basis, and only they cover the basic expenses, which, in turn, prevents them from paying their debts. In this way, those debts begin to grow on different fronts, the owners start using their credit cards more and more (even to pay the debts of other credit cards,) and in a short time they must file for bankruptcy
In this post, we will not talk about how to manage your money to avoid these unfortunate situations, but what to do when the worst has already happened: You can’t pay your debts, but you do not want to keep your arms crossed.
So, one of the most common options in terms of debts that can’t be paid is refinancing. People often confuse this concept with restructuring, but, in reality, they are essentially different. Let’s analyze each one and their basic features and consequences.
Refinancing a debt means, in a nutshell, to change the initial terms of the credit that you have to pay (for example, the term, or the necessary amortization to make the whole payment possible or just easier to carry out.) On the other hand, restructuring is, above all, a form of refinancing in which all the credits are grouped into a single debt and, in this way, they become one. Refinancing is characterized by the fact that the interest rate on the new debt depends on the new terms and conditions to be agreed with the lender (almost always, financial institutions, of course).
Read also: Embracing change: three aspects that will make restructuring less stressful, by Suzzanne Uhland
The great confusion here is that, on the one hand, restructuring a debt involves the optimization of contracted financial operations, so that a combination of new operations is sought for reducing the total costs of financing; while refinancing, although, in fact, also involves restructuring a loan, has a different objective: To accumulate financial charges. Even though this means to reduce the costs related to the payment of interest on several debts, the aim here is not to decrease the financing costs of operations per se.
Which are the real benefits of refinancing and restructuring? The advantages of restructuring a debt are, in particular, the anticipation of a possible default, the possibility of planning better the methods of payment, since the debt is adjusted to the real capacity of the debtor (and, in addition, without default interests.) The problem here is that the terms will be longer and, despite it is more comfortable to pay, the life of such credit will extend two or three more years and may end up paying more than the double of what was initially indebted. That is why restructuring should be your last option.
Refinancing debts also allows you to improve the payment plan because it extends to longer installments, but even the installments become easier to pay because they actually decrease. In addition, even if the credit value increases, the new installments do not affect the debtor’s income. Also, it is important to say that refinancing a debt does not affect a debtor’s credit history, so it is possible to ask more loans safely, and that is one of the reasons why financial institutions generally always offer refinancing plans. The main problem here is that some banks may simply say no to your offer.
Now, the most sensible decision depends on the evaluation of your company’s financial circumstances. If you are really getting through serious financial difficulties (for example, because there is simply no cash flow in your business,) and you have already filed for bankruptcy in the past, it is best to restructure your debts and provide sufficient evidence of your situation before starting any type of negotiation. If on the other hand, you are not going through financial problems, and, in fact, you want to avoid them because you know that you just can’t pay your debts the way they initially were agreed, then it is best to refinance your debts in this case.
Always remember to show a clear and transparent budget, as well as a realistic payment plan when conveying with the banks. You can be sure about something: In many cases, banks will slightly modify your restructuring or refinancing offers. Hand over if it is necessary. As Al Pacino says in Devil’s Advocate, we are always negotiating.
* Featured Image courtesy of familytreasures at Flickr.com