An example of a structured debt instrument is a mortgage that contains provisions to switch between fixed and variable interest rates.
Also known as personalized debt or custom debt, structured debt is some type of debt instrument that the creditor has created and tailored to meet the needs and circumstances of the borrower. Such a debt package generally includes one or more incentives that encourage the debtor to do business with the creditor rather than seek to develop a working relationship with other creditors. While the general structure of the debt is tailored to the needs of the borrower, the terms also benefit the lender in the long run.
An example of a structured debt instrument is a mortgage that contains provisions to switch between fixed and variable interest rates. An option of this nature would allow the borrower to start the mortgage at a very competitive fixed rate, but switch to a variable rate after a certain period of time. This creates a situation where the borrower can take advantage of any drop in the average interest rate that is likely to remain in effect for an appreciable period of time. In this scenario, the debtor can minimize the amount of interest that is paid over the life of the mortgage, thus reducing the total amount of debt.
Other business incentives may be included in a structured debt scheme. One option is to extend the grace periods longer for down payments. This benefit can be very helpful for a business that is trying to rebuild after going through a rough patch, but hasn’t yet gotten to the point where it can comfortably handle payment.
Another common option is to defer interest owed until the end of the loan. A popular option with bond issues, a deferred interest agreement allows the borrower the maximum amount of time before having to disburse a payment to the lender. The debtor has a better chance that the project financed with the proceeds of the bond will begin to generate income that can cover the payment of principal and interest due.
The primary purpose of structured debt is to create a debt situation that provides the debtor with as many benefits as possible while keeping the total debt burden as low as possible. At the same time, the creditor receives a fair return for the structured debt arrangement. Assuming both sides are satisfied with the outcome of the deal, there’s a good chance they’ll resume negotiations at some point in the future.