Debt restructuring guide
Debt restructuring is intended to replace an existing loan or to combine several loans with a new installment loan.
Reasons for debt restructuring
The reason for a debt restructuring measure is that the borrower wants to use the new loan at a lower interest rate than the one that he has to pay for the existing loan. The reason for this wish is usually that the general interest rate level has dropped so much that the debtor pays significantly less interest than before with the debt rescheduling.
Benefits of debt restructuring
Another reason for rescheduling may be that the borrower has to service several loans and would like to combine these loans into a new loan. In this way, he can reduce his overall burden and then only serves the one new loan. By paying a single loan installment, he also reduces his administrative workload, since he only has to serve one bank.
If several loan commitments have accumulated over the years, there is a risk that the borrower will be overwhelmed financially. If he is no longer able to service a single loan, he can risk the collapse of his entire credit exposure by terminating this one loan and the resulting negative Credit Bureau entry.
Impact of debt restructuring – disadvantages
The debt can be rescheduled through the previous bank. The borrower can also apply for a new loan from any other bank. However, he has to reconsider to what extent the debt restructuring actually brings financial benefits. If he repays an existing loan, he must expect to pay the bank a prepayment penalty for the previous loan. In addition, mortgage loans incur costs for the transfer of land charges to the new bank.
Loan notice periods
Inexpensive debt restructuring requires some time planning. It is readily possible when the fixed time of an agreed interest rate expires. Then the borrower can either make a special payment and reduce his debit or redeem the entire remaining loan by means of debt restructuring without incurring any costs on the part of the bank.
Notice periods for loans with variable interest rates
Loans with a variable interest rate are an exception. Here, the notice of termination can be given with a notice period of three months, so that debt can be rescheduled at short notice without any disadvantages.
Notice periods for simple installment loans
Simple installment loans can be terminated for the first time 6 months after payment with a notice period of 3 months. There will then be no prepayment penalty. However, the bank does not have to reimburse any processing fees and may request reasonable compensation for processing the termination.
A new regulation applies to installment loans that are concluded after June 10, 2010. The borrower may repay this early at any time, but the bank may request prepayment penalty. It is limited to a maximum of one percent of the early repayment. If the remaining term is less than a year, it may only be half a percent.
Which loans can be rescheduled
The debt restructuring can relate to any type of loan. It only depends on the period for which the interest rate is fixed.
Overdraft facility on the checking account
If the current account is in the red with a usually extremely expensive overdraft or overdraft, the account holder can reschedule at any time. There are no notice periods. Debt restructuring almost always makes sense here, especially because an installment loan is always cheaper than overdraft facility.
In the case of installment loans, which serve consumer purposes and mostly exist without collateral, and in the case of mortgage loans, the fixed interest period must be taken as a basis. The bank’s compensation claim associated with the termination determines the economics of rescheduling.
As a lender, the bank will not readily grant a debt rescheduling within an interest rate-fixing phase of a real estate loan. Here, the borrower must agree a termination agreement with the bank, which sets out the conditions for early termination of the current credit agreement. The situation can be illustrated using an example:
A borrower serves a loan of .$ 100,000 with a fixed interest rate of ten years. He effectively pays 6% interest, i.e. .$ 6,000 annually plus repayment. After six years, interest rates drop and another bank offers him the loan for 4% interest. He would save .$ 2,000 annually and, with a remaining term of his existing credit contract of four years, almost .$ 8,000 in interest and would like to reschedule.
In the event of early termination, the bank will refer to its interest loss. This arises from the fact that the bank could only resell the capital received from the borrower as a result of debt restructuring at an interest rate of 4% and, taking into account the remaining term of the loan contract of four years, would lose this .$ 8,000. It relies on the fact that the agreed credit contract must be complied with as a contractual agreement and cannot be terminated without further notice.
The same case arises if the borrower wishes to make a special repayment that is not provided for in the contract in the fixed rate phase. Here, too, the bank would have to forego its interest income.
Early termination right when selling the property
The case law has regulated the problem in such a way that the borrower can terminate a mortgage loan prematurely if he wants to sell the property. The reasons for this are irrelevant (illness, divorce, unemployment, favorable opportunity to sell). The bank has to agree.
The courts justify this view by saying that otherwise the borrower’s economic freedom of action would be restricted too much. To the extent that the borrower is only interested in obtaining a lower interest rate from the same or another bank, the bank does not have to agree to the early termination of the contract.
Calculation of a prepayment penalty
If the borrower can agree with the bank about an early termination of the contract, the bank will demand a prepayment penalty. It is regularly the subject of controversial disputes and keeps the courts busy.
According to case law, a bank can use two methods of calculation:
It can calculate its interest loss based on the refinancing costs, i.e. how much money it will lose when it invests the freed-up funds in fixed-income securities.
Alternatively, she can calculate her interest rate deterioration damage, which she will incur if she lends the capital from the loan contract of her terminating customer to a new borrower on poorer terms at lower interest rates.
Weighing up between prepayment penalty and continuation of the existing loan agreement
In general, the prepayment penalty has a higher impact, the more interest rates have fallen since the loan agreement was concluded and the longer the fixed interest rate on the loan has been running. The borrower who wants to reschedule must therefore offset the prepayment penalty against future interest savings and determine whether he actually drives cheaper.
Finally, he has to add the amount of the prepayment penalty to the remaining debt. His loan amount increases. Generally speaking, debt rescheduling is only worthwhile if the interest rate differential is at least 0.25%.
It may be cheaper to continue the existing loan agreement until the end of the fixed interest period. Even those who want to make a special repayment must consider whether it is cheaper to pay this amount into an interest-bearing investment and only to bring the capital into the existing loan agreement after the end of the fixed interest period.
Cost aspects when entering into a new loan agreement
The borrower must also note that he often has residual debt insurance for the existing loan. If this is also canceled prematurely, it must be clarified that at least the unused portion of the premium payment will be reimbursed.
Furthermore, he has to reckon with the costs of a new residual debt insurance for the new loan agreement. The premium increases with age. Notary fees and land registry fees apply to transferring a land charge to a new lender.
Debt restructuring requires continued positive creditworthiness
If the borrower wishes to terminate an existing loan agreement, he must take into account that the bank will re-examine its economic situation in order to determine the creditworthiness. If these have worsened or there is even a disadvantageous entry in the Credit Bureau, he risks waking sleeping dogs and jeopardizing his credit exposure.