Renegotiating loan interest rate

[PMC]

Participant has a loan for a 5-year period and has made the required payments. They now want to renegotiate the loan interest rate to see about lowering their payments and continue to repay at the same frequency and within the original 5-year period. Are there any pitfalls in doing this? Would this constitute a new loan and if yes, would there be any need to take into consideration the outstanding balance of the existing loan (E Outline Book indicates no need).

Is this as simple as just using the new interest rate on the remaining balance for the remainder of the 5-year period?

[Guest Sieve]

This is as uncomplicated a procedure as you suggest since your new loan is due no later than the maximum 5-year period of the original loan.

[JanetM]

Hang on one second, do you have a loan policy that sets the rate? If you do you will have to change the loan policy and do the same thing for anyone with a loan. Allowing one person to pay lower rate and applying standard rate to the rest is what will get your actions labeled arbitrary and capricious.

[Guest Sieve]

Of course, if the interest rate is set in the loan policy (in relation to prime, for example, or based on what other lenders charge in the area for comparable loans), it obviously applies only at the time the loan is made--i.e., all loans won't be at the same interest rate at all times. If other borroweres don't choose to refinance/renegotiate to the new, lower rate which is now available under the loan policy, that's certainly ok. Changing the interest rate in the loan policy certainly does not require the administrator to refinace every loan.

[JanetM]

Aren't refinance and renegotiate two different things?

[Guest Sieve]

I would say, generally, yes. Frankly, though, I thought PMC was using the word imprecisely, and really meant refinance--although I certainly can't speak for him/her--since I've never heard of an administrator truly renegotiate a loan (because the borrower has no real leverage in a participant loan situation--such as being unable to pay back). My assumption probably was imprecise.

[JanetM]

I assume the loan was take after jan 2005 since rates were lower than than they are now, but there is more than just the rate to look at. If the participant wants to refinance the loan does your recordkeeper simply reamortize the remaining loan at new rate? If so, is there a new loan fee? Does the interest saved exceed the loan fee enough to justify the change?

I ran the figures, if you borrowed $5,000 on 8/01/06 at 8.25% and refied on 8/01/08 with balance of $3243 at 5% you would save $5 per month. The savings would exceed cost of loan. But if you had taken $5,000 on 8/01/05 at 6.25 and refied on 8/01/08 with balace of 2,188 at 5% the savings would only be $1.25/month for 24 months.

[masteff]

1) I concur w/ Sieve that the OP (PMC) needs to be looking at this as a refinancing as permitted under the revised regs. Plan loans cannot be "renegotiated" as such (there's not mechanism for it). Options are refinance (assuming document allows it) or payoff loan and take a new one. That said... if the plan document / loan rules don't allow for it, then you'd have to amend because it can't be done otherwise.

2) Doing a quick "back of the envelope" I concur w/ Janet's last assessment... there's is a pretty small impact on the payment from doing this. Make sure the participant understands the actual change in payment that would result from a refi and make sure they want to go thru with it.