Loan restructuring part 1 – how to solve the problem of loan repaymen

The global economic situation caused by the COVID-19 pandemic has meant that, following the market recovery, we are currently witnessing an increase in inflation, not only domestically but worldwide. The ongoing war in Ukraine is also having a significant impact on inflation, with the sudden rise in fuel prices, for example. However, there are many more causes of inflation and they should not be identified only with the above two circumstances. Currently, according to the Central Statistical Office, the prices of consumer goods and services in June 2022, compared to the same month last year, increased by 15.5%[1] and this is the highest result since March 1997 (inflation was 16.6% then). According to the latest information, the aforementioned inflation level has also been maintained in July 2022. The consequence of this state of affairs is that the Monetary Policy Council regularly raises interest rates and, consequently, loan instalments increase. It is therefore not surprising that more and more people, especially borrowers, feel extremely concerned about this situation and are looking for a solution to the problem. One such solution may be to restructure the loan.

How does inflation and changes in interest rates affect the cost of credit?

The interest rate, in the simplest terms, is the cost you have to pay for borrowing money – for example from a bank, expressed as a percentage per annum. Changes in interest rates have a direct impact on loan instalments, as they translate, among other things, into interest rates, which is why, in the case of loans based on variable interest rates, one speaks of so-called interest rate risk. When interest rates rise, so does the WIBOR (WIBOR – the interest rate on loans that commercial banks lend to each other). Loan instalments therefore become higher. Raising interest rates, on the other hand, depends on a number of factors such as:

1. inflation;
2. economic growth rate;
3. the unemployment rate;
4. public finance situation;
5. retail sales;
6. exchange rate levels.

Inflation is considered to be one of the most important factors influencing the level of interest rates. Changing the value of interest rates is one of the main tools for controlling this process. The increase in interest rates is therefore the Monetary Policy Council’s response to rising inflation. On 7 July 2022, the Monetary Policy Council held a meeting at which interest rates were increased by a further 0.50 per cent.

The Monetary Policy Council’s resolution came into effect on 8 July 2022[2] and this is the tenth rate increase since 2021/2022.

Debt restructuring – what does it consist of and who can benefit ?

The Banking Law, in Article 75c(3), states that:

“The bank should, at the borrower’s request, allow for debt restructuring by changing the terms or dates of loan repayment specified in the agreement if it is justified by the bank’s assessment of the borrower’s financial and economic situation[3]“.

Debt restructuring, otherwise known as loan restructuring, is available to borrowers who are having problems with current loan repayments under the existing terms. This is most often related to:

• loss of main source of income;
• reduced earnings;
• temporary liquidity problems;
• a fortuitous situation (e.g. illness of a loved one that requires financial outlay for medical treatment).

The restructuring of a loan is nothing more than a change in the content of the loan agreement. An application with a proposal to amend the agreement and a restructuring plan should be submitted by the borrower. It should be remembered that the Bank is not obliged to agree to the proposed contract amendment. The main purpose of restructuring is to protect the borrower from termination of the agreement by the Bank and to enable the borrower to repay the loan on new terms taking into account his current financial and economic situation, which is assessed by the Bank. Restructuring is considered as assistance provided by the Bank to the borrower, which may involve additional costs for the borrower. Most often, restructuring involves extending the repayment period of the debt by reducing the amount of instalments or suspending the repayment of the loan. The above solutions result in an extension of the term of the contract and, consequently, an increase in the cost of the loan.

The most popular ways of restructuring a loan include:

• Suspension of loan instalment payments – known as credit holidays. This is a solution involving the suspension of payment of one or more loan instalments. This method of restructuring can be used provided that the instalments are paid on time. This solution is an ideal option for people who have short-term problems in repaying their debt. Credit holidays are now also a form of government support for borrowers.
• Capital repayment grace period – this method involves suspending repayment in relation to the capital portion. The borrower repays only the interest portion of the loan during the grace period, while the unpaid principal is added to subsequent loan instalments which the borrower repays after the grace period ends.
• Extension of the loan period – the use of this method makes it possible to reduce the amount of the monthly instalment, but the longer repayment period automatically extends the interest period. This is very important as the above will increase the total cost of the loan.
• Shortening the loan term – depending on the needs, restructuring may also consist in shortening the loan term. In this case, although there will be an increase in the instalment of the loan, at the same time the overall cost of the loan will be reduced, for example by shortening the interest period. In practice, therefore, the shorter the loan period, the less the increase in the interest rate affects the loan instalment.
• Changing equal instalments to decreasing ones – in theory, this procedure makes it possible to reduce the cost of the loan. A very big advantage of decreasing instalments is the fact that they allow a faster repayment of the capital part of the credit, thus also the amount of interest charged by the bank decreases faster. However, it should be borne in mind that usually at the beginning the cost of servicing a loan with an equal instalment is much more expensive than in the case of a decreasing instalment system, and not everyone can afford this type of solution.
• Balloon payments – this is a way of changing fixed instalments into increasing instalments. Balloon instalments mean that the borrower pays very low instalments at the beginning of the loan, often just the interest, but these instalments are increased over time. This method will be beneficial for people who are in a difficult financial situation, but who hope that this situation will improve significantly over time, as in the final phase of loan repayment the instalment will be much higher than at the beginning.
• Conversion of credit – this is often a very profitable option – but, as holders of franking credits have already found out, also a risky one, as it involves the possibility of fluctuations in the exchange rate of the currency in which the credit was taken in relation to the currency in which it is repaid, this is known as currency risk. Conversion of a loan involves not only a change in the currency of the loan, but also a change in its interest rate, which may be more favourable than for the Polish currency. Thanks to currency conversion, one can count on a lower interest rate, but on the other hand, exchange rate and currency risk arise, which can also increase the cost of the loan.
• Debt consolid ation – borrowers who have more than one credit commitment may opt for so-called debt consolidation. As a result of consolidation, several obligations in the form of loans or credits are combined into one. From the moment of consolidation, the borrower will pay a single loan instalment and the interest rate will be unified. However, if the combined loan instalment is reduced, an increase in the cost of the loan must be taken into account.
• Establishing additional security – a reduction in the monthly credit instalment can also be achieved by establishing additional security for the repayment of the credit, e.g. in the form of a mortgage.
• Reduction of interest rate and other credit costs – this method of restructuring is the least popular and the most difficult to negotiate with the bank, as it is connected with a reduction of profits, which would be brought to the bank by repayment of credit on the current terms. Nevertheless, it is worth negotiating with the bank, as it is also the bank that cares about regular repayment.

As you can see, there are many options for restructuring and the way in which restructuring is carried out depends mainly on the needs and possibilities of the borrower. In the next part of this article, we will outline the practical issues involved in restructuring a loan.

[1]https://stat.gov.pl/obszary-tematyczne/ceny-handel/wskazniki-cen/wskazniki-cen-towarow-i-uslug-konsumpcyjnych-w-czerwcu-2022-roku,2,128.html

[2] https://www.nbp.pl/home.aspx?f=/aktualnosci/wiadomosci_2022/rpp_2022_07_07.html.

[3] Banking Act of 29 August 1997 (i.e. Journal of Laws 2021, item 2439, as amended).

Author: Katarzyna Anioł