What is Structured Debt?

Malcolm Tatum

Also known as tailored debt or customized debt, structured debt is some type of debt instrument that the lender has created and adapted to fit the needs and circumstances of the borrower. A debt package of this type usually includes one or more incentives that encourage the debtor to do business with the lender, rather than seeking to develop a working relationship with other lenders. While the overall structure of the debt is adapted to the needs of the borrower, the terms also benefit the lender in the long term.

One example of a structured debt instrument is a mortgage that contains provisions to shift between fixed and variable rates of interest.
One example of a structured debt instrument is a mortgage that contains provisions to shift between fixed and variable rates of interest.

One example of a structured debt instrument is a mortgage that contains provisions to shift between fixed and variable rates of interest. An option of this nature would allow the debtor to begin the mortgage with what is a very competitive fixed rate, but switch to a variable rate after a certain amount of time. This creates a situation in which the debtor can take advantage of any drops in the average interest rate that are likely to remain in effect for an appreciable amount of time. In this scenario, the debtor is able to minimize the amount of interest that is paid over the life of the mortgage, thus reducing the total amount of the debt.

Other business incentives may be included in a structured debt scheme. One option is the extension of longer grace periods for balloon payments. This benefit can be very helpful for a business that is attempting to rebuild after going through a difficult period, but has not quite reached the point where it can comfortably manage the payment.

Another common option is deferring interest due until the end of the loan. A popular option with bond issues, a deferred interest arrangement allows the debtor the maximum amount of time before having to disburse a payment to the lender. The debtor enjoys an increased chance that the project funded with the proceeds from the bond has begun to generate revenue that can cover both the principle and interest payments that are due.

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The main goal of structured debt is to create a debt situation that provides the debtor with as many benefits as possible, while also keeping the overall debt load as low as possible. At the same time, the lender receives an equitable return for the structured debt arrangement. Assuming that both parties are satisfied with the outcome of the arrangement, there is a good chance they will do business again at some point in the future.

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Discussion Comments


@Oasis11 - I think that this type of creative financing is what got a lot of people into trouble because the variable rates kept adjusting, and they were not able to keep up with the payments.

I was listening to this financial advisor on the radio the other day and he suggested that most people should try to obtain a 15 year fixed mortgage which offered the lowest interest rates. He also added that this mortgage should not constitute more than 25% of your take home pay. He added that this is what he would suggest to anyone looking for the best structured debt plan because with this type of set up you are forced to pay down the debt faster and save money on the overall interest rate payments.


@Moldova - I know what you mean. Every time I go into a bank they always offer home equity lines of credit and home equity loans for debt restructuring. While on the one side it does eliminate higher interest rate debt, it also puts your home in potential jeopardy because this type of debt obligation is a recourse loan meaning that the bank can take your house if you default whereas with a credit card default, the company may sue you to get the rest of the payments, but they will never be able to take your home. I was listening to a financial guru the other day explain this.

The only time that I used a home equity line of credit was to buy a vacation home. For me it was my only option, because I was looking for a vacation condo and the majority of the buildings had a higher than average foreclosure rate, and since most of these properties were in resort areas the owner occupancy rate was below 50% which were two conditions that the bank stipulated in order to get a mortgage loan on the condo.

I had to essentially pay cash for my condo and take out a home equity line of credit on my primary home that was luckily paid off in order to be able to buy this property because I was approved for a mortgage, but the bank blacklisted many of these condo buildings because they saw these loans as too risky.

Luckily I am almost done paying back this loan, but I am always watching the interest rates because I have a variable rate, and so far they are still low.


@Brickback - I wanted to say that there are also hybrid loans that allow a low fixed rate for the first two years and then the rate will jump to an adjustable rate mortgage which depending on your credit could start at the prime rate for excellent credit or start a few percentage points above the prime rate. On the plus side you really receive the lowest possible payments because the debt obligation is structured to only payout the interest.

However, that could be bad too, because you still have to pay the principle no matter what, so if you are not disciplined enough to make extra payments then I would avoid this type of debt structure. I have a home equity line of credit and I make extra payments so that I can pay off my loan faster.

The bank initially gave me ten years, but stated that I could extend that period if I wanted to. They also told me that after the ten years were up, I then would begin making payments for ten more years, but this time if would include the principle.

It can be easy to put off paying extra on the loan then you are faced with the entire loan all over again once then initial payback period is over. It can be too tempting to put off making extra payments and get used to the lower payment, but by then you will have a mountain of debt at the end of your term.


I think that collateralized debt obligations like a home equity line of credit or a loan can be a double edged sword. A lot of this collateralized debt can either be a fixed rate which is usually several percentage points higher than the going interest rate, or it could be a variable rate, which is what I have which can offer a below market interest rate but it does not touch the principle. The fixed rate option allows for a predictable debt structure, but it offers above market interest rates and the amount that you are borrowing is set and you have to begin making payments right away.

The home equity line of credit can offer below market interest rates, but the line is set up as an interest only payment plan which can offer you a lower payment on the front end, but you will have to pay the principle on the backend.

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