Monday, April 06, 2020

How can I meaningfully reschedule a loan?

A debt rescheduling is done to redeem a loan with a relatively high interest rate by taking out a new loan with lower interest rates. This offers immediate cost savings, which however have to be calculated. In theory, rescheduling pays off with any kind of interest savings, in practice the effort is particularly worthwhile in certain cases, but sometimes hardly.

The basic principle of debt restructuring

The basic principle of debt restructuring

There are situations in which money is urgently needed and therefore an expensive loan is taken out. The self-employed and freelancers in particular often receive loans at double-digit interest rates. In 2011, the highest interest rates on the market were 17.90 percent; in 2007, when the key European interest rates were still in the region of 4 percent (2011: 1.5 percent), loans to self-employed people did well with interest around 19 Percent assigned. On the one hand, this was due to the overall higher interest rate level, and there were also higher interest rates for overnight deposits and time deposits.

On the other hand, the person concerned could also be in a position in which the loan was not possible on other terms. In the meantime, not only has interest rates on the market dropped, the person who took out a 19 percent loan in 2007 can now stand financially on better terms and would therefore receive a loan at interest rates of possibly 12 percent. This savings in interest would be enormous. If the old loan still had a term of two years and a remaining debt of 10,000 USD, 5 percent interest savings would save 801 USD. The invoice results from the annuity repayment, in which the interest component falls, the repayment component increases in the installment.

This calculation was carried out with an online calculator, the exact calculation is carried out by every bank with sophisticated computer programs, the interest is actually calculated to the day. The basic principle is apparent from this. In the private area, all people can understand that who are continuously debiting their checking account. Interest is often due here by 12 percent and more, if the disposition is not balanced, the debt increases due to the interest alone. If, for example, these people can take out an installment loan with 6 percent interest, they will also benefit greatly from the savings.

The sensible debt restructuring

The sensible debt restructuring

Of course, the savings only result if the annual percentage rate is lower than the previous loan, and that also depends on the term. If only the nominal interest rate is compared and a new, supposedly cheaper loan with a significantly longer term is taken out, the effective interest rate may be higher than for the previous loan. This is sometimes sought to reduce the rates. Basically, it would be enough to negotiate with the previous lender, but sometimes relationships are strained because, for example, an installment was paid late at some point. Then they quickly look for a new lender, who also offers a lower nominal interest rate, and the rates are also reduced by extending the term.

This can make debt restructuring more expensive than if the old loan had been paid off according to plan. Since several factors come together here, namely the nominal interest rate, the term and the resulting effective interest rate, and probably also transaction fees, a comparison can only be made using the effective interest rate of the new loan, or even better, using the nominal cost statement shown in a monetary amount. It is also necessary to check whether the old loan can be redeemed without prepayment penalty.

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