When rescheduling, the obligations are changed, but not the amount owed. To repay loans, the borrower can choose other forms of credit and / or change the lender. The need to reschedule existing debt can arise for a number of reasons: particularly low market interest rates are used or excessive costs of existing credit obligations have to be avoided. Securing liquidity by extending the loan terms may also require rescheduling.
Certain loan relationships, such as a maturity loan or mortgage loan and other fixed-interest loans that expire, will also have to be rescheduled. Loans can be rescheduled by private individuals, companies, but also states.
Paths into the debt trap
While debt restructuring is often the only way out of the debt trap for the borrower, excessive borrowing, the use of expensive overdraft facilities or bad economic decisions quickly lead companies and private individuals into the debt trap. Loans can be rescheduled if the borrower can barely meet the cost of the loan and an adequate repayment of the liability is impossible. With the debt rescheduling, usually lower interest rates, longer terms and therefore generally lower repayment rates are agreed.
In particular, entrepreneurial bad investments (investments or participations), high losses or insufficient equity available in the short term can lead to the insolvency of companies. In the past, it was mostly corruption, bad economic investments and high armaments expenditure – or a combination of the factors – that led to overindebtedness.
Benefits of debt restructuring
The conversion of existing credit relationships can reduce interest charges and / or repayment rates. In accounting terms, the interest charges are expenses in the sense of accounting, while the repayments burden the liquidity of the borrower. To avoid over-indebtedness or insolvency, cheaper financing options should be used. Not only companies, but also private individuals can go bankrupt. In addition to the affidavit, personal bankruptcy is an option for natural persons to be released from payment obligations in a given period. Even during private bankruptcy, the involved insolvency administrators and advisors try to consolidate and reschedule the loans.
However, the debt relief often associated with personal bankruptcy is not a debt rescheduling in the legal sense. The debt rescheduling ideally leads to a reduction in the repayment burden (due to lower interest rates and possibly adjusted repayment modalities) and can thus improve the liquidity and thus the scope of action of the borrower.
Debt restructuring opportunities
Lower interest rates, also due to the change between fixed and variable interest, lead to lower costs for the loan, which enables higher repayments. A financial relief can also be brought about by extending the loan term. The consolidation of loans, which converts short-term into long-term liabilities, enables a longer loan term. The long-term liability is mostly used to offset existing short-term loan agreements.
Suspension of repayments or final repayments, also called “bullet payment” (repayment at the end of the term), are also suitable measures to ensure the liquidity of the borrower. Neither the deferral nor the debt relief count as rescheduling, since in these cases the debt is not reduced by repayments; in the event of a deferral, interest and repayments due are only suspended and thus deferred. However, if the deferral affects the term, this extension is considered a debt rescheduling.
Legal implications of debt restructuring
If the obligation remains and is only changed by additions such as contract supplements or supplements, then it is a change in obligation. However, if a new credit contract is concluded, with or without a change of lender, there is a novation with which the original credit relationship ends in accordance with §241 BGB. In the case of in-house debt restructuring, for example to replace a current account credit with an installment loan from the house bank, there is basically a contract change. As a legal consequence, a guarantee for the current account credit may be transferred to the new loan.
Debt rescheduling in the private sector
Debt restructuring offers itself not only to benefit from cheaper interest and repayment rates, but also to restore creditworthiness. In the private sector, debt rescheduling can be used to combine the loans resulting from various obligations, such as partial payment purchases from mail-order companies, installment loans and bank overdrafts, to form a total debt. A longer loan term, combined with cheaper annual interest rates (nominal interest plus the loan costs) enable the borrower to have an improved financial situation and easier and more transparent planning of the financial budget.
When rescheduling the loans, it should be noted that additional costs may arise for the termination or for taking out or providing the subsequent loan. Loans with variable interest rates can generally be terminated with a notice period of three months. Fixed-rate loans can be terminated six months before the fixed interest rate expires. If a fixed interest rate of more than 10 years has been agreed, this can still be terminated at the end of the 10-year period.
If, however, the fixed-interest loan contract is terminated before the fixed interest period expires, the lender will request a prepayment penalty (VFE), which was agreed upon when the loan contract was concluded. Depending on the possible new conditions, even the payment of the prepayment penalty can have an advantageous effect on the financial situation of the rescheduling borrower – for example, if the savings from the new conditions exceed the costs of the VFE. In the event of early repayment of home loan, no prepayment penalty will be charged.
Mortgage loans that are granted when buying or building real estate are usually provided with a fixed interest period, after which rescheduling of the remaining debt must be entered into. The follow-up financing can be concluded with the lending bank or with a new lender, although additional costs for the changes to the land register entries are due and must be paid by the borrower. The mortgage loan is also suitable for debt rescheduling in the private sector, for liabilities that are not caused by building a house or acquiring a home. Mortgage rates are usually particularly attractive due to the transfer of property rights.
To ensure rescheduling or follow-up financing, the borrower can also take advantage of a forward loan. The forward loan ensures the favorable interest rates on the capital market for a loan that will be sufficient in the future. However, the lender charges a fee for the period until the loan is paid out: the commitment interest. Interest payments on the loan or repayments, however, are only due when the loan amount is paid out in the future.
Debt restructuring of corporate loans
In certain legal forms, such as the GmbH (limited liability company), the entrepreneur is legally obliged to report insolvency. Failure to do so could result in fines and imprisonment. However, investors and capital providers of the company must also be informed about critical indebtedness and the financial situation of the company. In order to determine the solvency and the financial basis of the company, business indicators are used, which can also be used to analyze the equity and debt structure or the level of debt.
The company’s debt sustainability results from the ratio of liabilities, including lending service (interest and repayment service) to cash flow. If the liabilities permanently exceed the operative cash flow by 400 percent or if the debt service exceeds 50 percent of the cash flow (DCR), the company’s debt situation is considered critical – although more accurate comparative figures depend on the industry. The debt cover ratio (DCR), also known as debt service coverage ratio, states whether the cash flow is sufficient to service the debt or whether the servicing of the loans is at risk. If the DCR is exceeded permanently, the company is in crisis. It makes sense to seek debt restructuring with the creditors with the highest liabilities.
Countries in crisis can also consider rescheduling their foreign debt, but this is not referred to as rescheduling, but mostly as “restructuring”. The extent of the state crisis can also be determined using key figures. The states are supported by the World Bank, the Paris Club or the International Monetary Fund (IMF) in debt rescheduling.