What is debt forgiveness?
It’s possible to have debt forgiven, but beware the consequences
Despite having a budget and managing your expenses, you still might find yourself in debt. If you’re struggling to pay your bills every month, you’re likely looking into options like debt forgiveness.
Debt forgiveness is the cancellation of all or part of a debt owed by an individual or entity. It can be a lifesaver for those who are facing financial hardship, providing a way to escape the crushing weight of debt and start fresh.
Key insights
- Debt forgiveness is when a lender forgives the total balance or a portion of the total debt you owe.
- There are different types of debt forgiveness for different types of loans, including student loans, medical debt, credit cards, mortgages and tax debt.
- Alternatives to debt forgiveness include debt settlement, credit counseling, debt consolidation and bankruptcy.
How does debt forgiveness work?
Debt forgiveness is when a lender or creditor cancels or reduces a borrower’s outstanding debt obligation, explained Tracy Cauley, a chartered financial analyst at VEM Medical. Cauley says that debt forgiveness can happen in situations such as when the borrower can’t repay the loan due to financial hardships.
While debt forgiveness sounds like the ideal solution, total forgiveness is not common, and the process is not easy. If you get a proposal for debt forgiveness that sounds too good to be true, be on alert. There are likely just as many debt forgiveness scams as there are actual debt forgiveness programs available.
Legitimate debt forgiveness typically considers factors such as income, ability to pay and financial circumstance. For instance, if you’ve experienced a job loss, medical issue or other financially devastating event.
Types of debt forgiveness
When you think about debt forgiveness, you might automatically go to student loan forgiveness. While student loan forgiveness is a big one, there are also other types of loan forgiveness programs.
- Student loan debt
- Despite government efforts to implement one-time student loan forgiveness of up to $20,000 to Pell Grant recipients and $10,000 to non-Pell Grant recipients, student debt relief has been put on hold. Currently, applications are not being accepted as the court has issued a block on the student debt relief program.
If this program does go through, student loan relief will not be taxed at the federal level. However, some states might require you to pay taxes on debt relief — you’ll need to check with your state. Student loan repayments have been on hold since the start of the pandemic and will likely resume in the summer of 2023.
If you’re employed by the U.S. government or a nonprofit organization, you can also look into the Public Service Loan Forgiveness (PSLF) Program. If you work as a teacher, you might find relief through the Teacher Loan Forgiveness Program.
- Medical debt
- Over 100 million people in America carry medical debt. In a 2022 report, the Consumer Financial Protection Bureau (CFPB) reported that 58% of debt in collections is medical debt.
To avoid having your medical debt go to collections, the best thing you can do is deal with it as soon as possible. Reach out to your hospital or health care provider directly to see if there are debt relief options available or if you can set up a payment plan.
Medical debt forgiveness varies from state to state. Some states, such as Oregon and Texas, require certain nonprofit or state-owned hospitals to provide financial assistance to patients who meet income requirements. Other states provide special assistance programs that pay the cost of care for eligible patients. And some states have no mandated financial assistance programs, but individual hospitals implement their own financial assistance policies.
- Credit card debt
- While the chances of your credit card issuer forgiving your total balance are slim to none, you can try to negotiate to make your debt more manageable. To do this, reach out to your issuer directly. The earlier you can do this, the better.
Explain why you’re unable to manage your payments. Is there an extenuating circumstance (e.g., job loss, medical issue, divorce, etc.) preventing you from being able to pay? Many credit card companies offer hardship programs that allow you to temporarily lower your interest rate or waive fees for a period of time. If your issuer is willing to negotiate, you can try proposing a payment plan you can realistically afford.
- Mortgage debt
- During the Great Recession of 2007 to 2009, there was also a nationwide foreclosure crisis. Some estimate this crisis lasted nearly a decade, with as many as 10 million borrowers losing their homes.
The Mortgage Forgiveness Debt Relief Act was released in 2007 through 2017, allowing taxpayers to exclude income from the discharge of debt on their principal residence (up to $2 million). This included debt relief through mortgage restructuring as well as mortgage debt forgiven during foreclosure.
In December 2020, the Consolidated Appropriations Act was passed in response to the pandemic. It extended the exclusion for canceled mortgage debt through the end of 2025. This exclusion is for qualifying residents up to $750,000.
The government also offers a number of loss mitigation programs to assist Federal Housing Administration (FHA) insured homeowners facing financial hardships. This includes programs like a forbearance plan that allows borrowers to work with their mortgage lenders to temporarily pause or reduce their monthly payments or negotiate specific repayment terms.
» MORE: What is preforeclosure?
- Tax debt
- If you have tax debt, you can apply for an offer in compromise. This program allows you to settle your tax debt with the IRS for less than the full amount you owe. Acceptance in this program depends on factors such as your income, expenses, asset equity and ability to pay.
Offers are typically accepted when the amount you propose represents the most that the IRS can expect to collect within a reasonable period of time. There is a $205 application fee; however, if you apply and aren’t eligible, the fee will be returned with your application.
How do you apply for debt forgiveness?
How you apply for debt forgiveness varies based on the type of debt you have.
- Reach out on your own. Reach out directly to the loan provider, such as a credit card issuer or a health care provider, as soon as you know you are struggling. Taking immediate action usually results in more options.
- Work with a debt relief company. You can hire a debt settlement company (or a tax relief company for tax debt) to negotiate debt forgiveness on your behalf. But do your research. Some companies make extreme promises they can’t keep. Others charge expensive fees with no guarantee they can reduce your debt. Your creditors do not have to work with a debt relief company.
To avoid getting scammed by any debt forgiveness promise, contact your state attorney general and local consumer protection agency to see if any complaints have been filed against the company you’re considering.
Pros and cons of debt forgiveness
While debt forgiveness may seem like an easy solution, it comes with both pros and cons that you’ll need to carefully consider.
Pros:
- Possible debt elimination: If you’re able to reduce a portion of your debt, this means you no longer have to pay it.
- Reduce the time to pay off debt: Eliminating a portion of your debt might also increase the speed at which you can pay it off
- Avoid bankruptcy: If you’re on the verge of bankruptcy and debt forgiveness allows you to get back on track, you can count this as a win
Cons:
- Tax implications: If a lender agrees to cancel or forgive a debt, you might have to include the canceled amount as part of your income and be taxed accordingly.
- Lots of scam debt relief agencies: It’s important to research any debt relief company before you agree to work with them.
- Additional costs: Some debt forgiveness options might end up costing you more than you originally owed. For instance, if you work with a debt relief agency that demands upfront fees and then fails to negotiate a reduction in your debt.
Alternatives to debt forgiveness
Debt forgiveness is rarely a sure thing. Thankfully, there are other options at your disposal to help you tackle your debt.
- Debt settlement
- Debt settlement companies negotiate with creditors on your behalf. If the company is successful (which is not guaranteed), you will have to pay a lump sum to your creditors.
Debt settlement companies often advise you to stop paying your debt while it tries to negotiate a settlement. Unfortunately, this can negatively impact your credit score. If the debt settlement company is unable to negotiate a settlement, you can end up on the hook for missed payments. Not only will you have to pay your original balance, you may also owe the debt settlement company a high fee.
- Credit counseling
- Credit counseling companies are often nonprofit organizations and can advise you on how to manage your money and deal with your debts. Typically you can access free educational materials and workshops.
A credit counselor can help you negotiate with your creditors to prevent your debts from going to collections. However, if you’re looking to reduce the amount of your debt, credit counselors don’t normally do this.
- Debt consolidation
- Debt consolidation is the process of rolling up several separate debts and paying them off with one loan or monthly payment. You can consolidate debt using a debt consolidation loan or a balance transfer credit card.
The benefit of debt consolidation is it can simplify debt repayment and possibly lower your monthly payment if you secure a low interest rate. However, debt consolidation will not eliminate any of your debt, and if you have a poor credit score you might find it difficult to secure a loan or a balance transfer credit card.
- Bankruptcy
- Bankruptcy is typically a last resort for people struggling with debt, yet it can provide a fresh financial start. While filing for bankruptcy can help to eliminate many unsecured debts, including credit card and medical debt, not all of your debts are eliminated. You also will likely have to part with some of your assets as a way of repaying some of your debts.
What does debt forgiveness cost?
The cost of debt forgiveness varies based on the type of debt and the approach you take. Whether or not you choose to work with a debt relief company can also impact the cost. Many debt relief companies charge high fees regardless of whether your debt is lowered.
Let’s say you have $10,000 in credit card debt and you hire a debt relief company to negotiate on your behalf. If you settle to forgive $7,000, you now only owe 30% of your original debt — but also 15% to 25% ($450 to $750) in fees.
If you end up working with an illegitimate company and get scammed, it will cost you even more.
Tax implications
The tax implication of debt forgiveness or cancellation depends on your individual situation. If you borrow money and the lender cancels or forgives the debt in the future, you might have to include the canceled amount as part of your income. Typically the lender will report the amount of canceled debt to the IRS.
If you end up filing for bankruptcy or you’re insolvent when your debt is canceled, you might not have to pay taxes on the canceled debts.
FAQ
Does debt forgiveness impact your credit score?
Debt forgiveness itself typically will not impact your credit score. Reducing your debt may have a positive impact on your credit score as it can help to reduce your credit utilization. However, if you use a debt settlement company or apply for bankruptcy to reduce your debt, these can negatively impact your credit score.
Is debt forgiveness the same as debt settlement?
Debt forgiveness and debt settlement (also known as debt relief) are not the same. Debt settlement typically involves hiring a third-party company to negotiate with your creditor(s) to reduce your debt. If your creditor agrees, the debt is paid out in a lump sum. However, your creditor is not obligated to negotiate.
Is debt forgiven after you die?
Debts are not typically forgiven after you die. Instead, the debts owed are paid from your estate. If there isn’t enough money in the estate to cover the debt, it may go unpaid. Your family members typically aren’t responsible for your debt unless they cosign on the debt or have other legal responsibilities.
How many times can you forgive debts?
You can try to ask for debt forgiveness more than once, but you might not be successful. There are certain debt forgiveness programs, such as the proposed Biden administration student debt-relief plan, that are only available one time.
What debts can be forgiven?
While there is no guarantee of debt forgiveness, you can attempt to have student loans, mortgages, credit cards, medical, and tax debt forgiven.
Bottom line
If you’re on the verge of insolvency and are seeking debt forgiveness, it’s best to reach out directly to your creditor or loan provider as soon as possible. The longer you wait, the more difficult it can be to negotiate. If your debt goes to collections, the process becomes even more complicated.
While debt forgiveness is possible, it’s important you weigh the pros and cons and consider alternate options.
- Article sources
- ConsumerAffairs writers primarily rely on government data, industry experts and original research from other reputable publications to inform their work. Specific sources for this article include:
- Kaiser Health News, "100 Million People in America Are Saddled With Health Care Debt.” Accessed March 25, 2023.
- Consumer Financial Protection Bureau, "Medical debt burden in the United States." Accessed March 24, 2023.
- National Consumer Law Center, "An ounce of prevention." Accessed March 24, 2023.
- Federal Reserve Bank of St. Louis, "The end is in sight for the U.S. Foreclosure Crisis," Accessed March 24, 2023.
- IRS, "Home foreclosure and debt cancellation." Accessed March 24, 2023.
- IRS, “Topic No. 431, Canceled Debt – Is It Taxable or Not?” Accessed April 7, 2023.
- IRS, “Offer in Compromise.” Accessed April 7, 2023.
- Federal Student Aid, “Teacher Loan Forgiveness.” Accessed April 7, 2023.
- Federal Student Aide, “Public Service Loan Forgiveness (PSLF).” Accessed April 7, 2023.
- WSJ, “When Will Student Loan Payments Resume?” Accessed April 7, 2023.
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