These days, it can seem like it's easier to get out of debt than to get into financial trouble in the first place. Of course, this isn't the case. While there are myriad ways to get tripped by up debt, there are only a few tried-and-true methods of extrication. Debt restructuring is often cited as an attractive alternative to more drastic measures like bankruptcy.
Debt Restructuring: A Conceptual Overview
"Debt restructuring" is a broad term that encompasses a variety of debt management strategies that share several common attributes. For starters, debt restructuring isn't designed to eliminate debts outright. While you might be able to enroll in programs that reduce the total amount that you owe, it's unlikely that you'll find a debt restructuring plan that completely does away with your obligations. However, it's likely that you'll be given more time and flexibility to pay off what you owe. We hit on some common forms of debt restructuring below.
Chapter 13 Bankruptcy
Chapter 13 bankruptcy is among the most common forms of debt restructuring. Unlike Chapter 7 bankruptcy, Chapter 13 doesn't force you to liquidate your assets. When you apply for this type of debt restructuring, you'll meet with your secured and unsecured creditors under the supervision of a bankruptcy judge or licensed mediator. Although every filing is unique, your unsecured creditors will probably agree to reduce the interest rates, principal balances or payment time frames on your outstanding loans. This will give you the breathing room that you need to remain current on your secured obligations. It's important to keep up with your restructured payment plans: If you fall behind on your obligations, your credit score could take a serious hit.
While mediation is similar to Chapter 13 bankruptcy, it's not often used by individual borrowers. If you own a small business that's fallen on tough times, mediation may be among your most attractive restructuring options. The process is straightforward: After notifying your creditors that you'll be unable to pay off your debts in their current form, you'll meet with your personal lawyer, a neutral mediator and your creditors' representatives. At this meeting, you'll hammer out new repayment terms that may reduce your loans' principal balances and interest rates.
While mediation is still more common in the business community, consumer-focused mediation has become more widespread since the collapse of the real estate market in the late 2000s. Since this process shouldn't hurt your credit score as much as a Chapter 13 filing, it's worth a closer look.
It sounds counter-intuitive, but many borrowers restructure their debts by taking out low-interest loans to pay off high-interest debts. In fact, a whole cottage industry exists to cater to debt-ridden borrowers who have subpar credit. Meanwhile, legitimate banks lend to more affluent debtors who have the collateral to back up their repayment promises. In either case, these loans come with long repayment windows and attractive interest rates. Since credit rating agencies frown on late payments or defaults, it's crucial to stay current on these lines of credit.
It's also possible to restructure your debt with the help of nonprofit agencies known as credit counselors. In exchange for a reasonable monthly fee, credit counselors negotiate with your unsecured creditors to secure reduced interest rates or more lenient repayment terms. While credit counseling can't restructure secured debts like mortgages or car notes, it can make such debts more manageable.
Final Thoughts: Better Than Bankruptcy?
There are many advantages to debt restructuring. Unlike Chapter 7 bankruptcy, restructuring won't have a catastrophic impact on your credit score. It'll also allow you to hold onto valuable assets like your car, home, boat and furniture. At the same time, it's important to remember that there's no such thing as a painless route out of debt. Before you commit to a debt restructuring plan, talk to a financial professional who can steer you in the right direction.