Americans have a serious personal debt problem, that's likely going to get worse before it gets better. According to the Federal Reserve Bank of New York, U.S. consumer debt rose to $12.84 trillion in the second quarter of 2017, its highest level since the initial months of the Great Recession, in the third quarter of 2008.
Credit card debt is particularly onerous. "Flows of credit card balances into both early and serious delinquencies climbed for the third straight quarter—a trend not seen since 2009," the Federal Reserve stated, in its latest quarterly Household Debt and Credit Report.
Home mortgages, the largest component of household debt, are on the rise, as well. "Mortgage balances, which stood at $8.69 trillion as of June 30, saw a $64 billion uptick from the first quarter of 2017," the Fed stated.
Debt consolidation and debt restructuring: two different ways to rebound
You don't need to be a Harvard University economics professor to understand that, with excess debt comes excess angst and worry. That's why, when household debt becomes too burdensome, consumers look for paths to reducing and even resetting that debt.
Two widely-used debt management tools, debt consolidation and debt restructuring, can fit the bill when looking to curb consumer debt loads, but in significantly different ways that financial consumers need to know about.
While debt consolidation and debt restructuring share structural similarities that can help consumers battle back against debt, they're not the same form of debt management relief.
- Debt Consolidation is the process that allows borrowers to refinance and/or turn multiple smaller (high-interest rate) loans into one single loan. "This makes it more convenient for borrowers to pay off their loan in a shorter amount of time and if it's a lower interest rate, then also with lower monthly payments," notes Leslie Tayne, a debt attorney at Tayne Law Group P.C. in New York City, and author of the book "Life & Debt." "The money previously used to pay the high interest of multiple loans can now be used to pay more towards the loan principal." (See also: Is a Debt Consolidation Right for You?)
- Debt Restructuring is the process in which a debtor and creditor agree on an amount that the borrower can pay back. "The debtor then works with a credit counselor to speak with creditors in an attempt to get out of the debt owed," Tayne explains. "For example, the debt counselor may negotiate with the creditor and say they will pay 40% of the debt back instead of the full debt. This can be successful if it's done right and with the proper handling."
Differences and similarities
While similar in some ways, debt consolidation is a different financial debt management tool than debt restructuring, in the following ways, Tayne says:
|Debt Consolidation||Debt Restructuring|
|Debt consolidation requires a brand-new contract and a new loan application.||Debt restructuring builds off an existing contract and more negotiation is involved.|
|Someone who files for debt consolidation doesn't necessarily have to be in financial hardship.||Someone who files for debt restructuring is usually in financial hardship.|
|Debt consolidation can actually increase your credit score (as long as the borrower keeps paying down the loan on time.)||Restructuring debt may hurt your credit score because borrowers are defaulting on original agreement. "It can hurt score for up to three years after final payment,' says Tayne.|
There are some important similarities between the two debt management tools:
- Both share the same goal of making debt more manageable.
- Both will change existing loan repayment terms and amounts.
- Borrowers on both loans are still required to pay some amount of their debt back. "This depends on if you refinance to a lower interest rate, then you will end up paying less back and if you are successful with negotiation, then you may end up paying less debt than you previously owed," Tayne says.
Members of the same loan family
Structurally, debt consolidation is a form of debt restructuring, and that's important for debt-fighting borrowers to know, other expert say. "The goal of consumer debt restructuring is to restructure your debt so it will have better terms that will make it easier for you to completely pay off your debts," explains Kevin Gallegos, vice president of Phoenix operations with Freedom Debt Relief, in Phoenix, Az.
The idea, says Gallegos, is that debt restructuring reduces the total of amount of monthly payments and/or the total amount of principal and interest paid." Understand that debt restructuring as a means of reorganizing debt can include many tools," he says. "One is debt consolidation and another is debt settlement."
For example, loans used to pay off creditors are generally known simply as personal loans. "They're also referred to debt consolidation loans, as they are designed to help people dig out of debt (particularly credit card debt)," Gallegos notes. "This points to "debt restructuring" as an umbrella term. In that regard, "debt consolidation" is one means of debt restructuring."
Choosing the right path
Which debt management loan option works best? That would largely depend on an individual borrower's unique financial situation.
As far as any impact on credit scores, both options offer risks and rewards to borrowers. For example, consolidating a loan can boost your credit score if you use the loan to pay off high-interest rate debt first, an outcome creditors want to see from borrowers. On the other hand, taking any loan usually has an adverse impact on your credit score, as loans represent debt, and thus are deemed a higher risk by creditors.
As for debt restructuring, chances are the borrowers credit scores will decline, as most debt restructuring deals, interest are often higher, representing more debt for the borrower and more risk for creditors.
That said, there are some uniform takeaways on both debt consolidation and debt restructuring:
- "Both will eventually clear debt," Tayne notes. "But in discussing what option works best, it depends on the circumstances and situation that you're in." For example, if you own a private or public business and you're falling into deep debt, and you're missing your payments and your credit score is being affected, then you may want to consider debt restructuring to help you get back on track financially, Tayne states. "Alternatively, if your business is doing okay and you want to expand to be more successful, but your debt is weighing you down, then you may want to consider consolidating your debt," she notes.
- It's also possible to engage in a strategy involving both debt restructuring and consolidation. "You may negotiate better payoff amounts with current creditors (via restructuring), and follow up by identifying a new creditor who can consolidate your renegotiated debts into one loan with better terms," notes Kyle Winkfield, managing partner of O'Dell, Winkfield, Roseman and Shipp, in Rockville, Md.
- There's no such thing as a "better option" when it comes to these approaches, as they are situation-dependent. "Factors in your life, like amount of debt, type of debt, credit history, employment status all contribute to how much room you have to negotiate or seek better terms," Winkfield states. "Debt is a personal battle and its effective management is on a case-by-case basis."
No doubt, both loan consolidation and loan restructuring bring plenty of unique benefits to the table for Americans battling heavy personal debt. Consult with a trusted financial advisor and thoroughly review which of the two loan options works best for you.
Editorial Disclaimer: Opinions expressed here are author's alone, not those of any bank, credit card issuer or other company, and have not been reviewed, approved or otherwise endorsed by any of these entities. All information, including rates and fees, are accurate as of the date of publication.
This article was originally published on November 3, 2017, and has been updated.