What is debt forgiveness?

When a lender forgives your debt, you are no longer obligated to repay some or all of what you owe

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Debt forgiveness is a financial relief option where a lender cancels part or all of your debt. Having a large debt balance forgiven can be a huge relief, but debt forgiveness is rarely as simple as it seems. It’s usually an option only if you are significantly behind on payments or have experienced a major financial hardship that makes repayment impossible.


Key insights

Debt forgiveness involves working directly with a creditor to have them reduce or eliminate a particular debt you owe.

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Debt forgiveness can ease financial burdens by canceling part or all of a borrower's debt, but it also comes with potential downsides.

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Understanding the tax implications of debt forgiveness is crucial as it may be considered taxable income.

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Debt forgiveness also affects your credit score, potentially impacting future borrowing opportunities.

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How does debt forgiveness work?

Most commonly, debt forgiveness is used in cases where your financial situation is suddenly and drastically altered. If you’ve been unemployed longer than expected, lost a primary income source, or faced unexpected medical expenses, debt forgiveness may help you avoid bankruptcy.

Unsecured debts — such as credit cards, personal loans and medical bills — are generally eligible for debt forgiveness.

“Debt forgiveness involves elimination of a balance owed to a creditor without payment and without intervention like bankruptcy,” said Josh Richner, the founder of FaithWorks Financial. “This process often applies to delinquent debts, typically after a charge-off at around 180 days of nonpayment,” he said.

While complete forgiveness is uncommon, creditors are more likely to offer partial forgiveness through debt settlement, where a reduced lump-sum payment satisfies the debt. Types of debt eligible for forgiveness or settlement are generally unsecured debts like credit cards, personal loans or medical bills.

How much does debt forgiveness cost?

The cost of debt forgiveness varies based on the type of debt and the approach you take. Working with a debt relief company can impact the overall cost, as many charge high fees regardless of the outcome.

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 your $10,000 debt for $3,000, you save 70%, but you may also owe 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.

How to request debt forgiveness

The process of requesting debt forgiveness is surprisingly simple, especially when compared to the arduous process of filing for bankruptcy, and can be done in one of the following ways:

  • Call your creditor: When your debt goes to a collections agency, you’ll receive a letter informing you of the name of the agency, along with a contact phone number. You can use this number to speak to an agent who can escalate your request for debt forgiveness.
  • Write to your creditor: In your correspondence, be prepared to provide documentation that demonstrates significant financial hardship. Examples of hardship documents include employment termination letters, foreclosure notices, obituaries or other proof of drastic circumstances, Richner says.
  • Wait for the creditor to call you: If your debt is severely delinquent, you’ll likely start to receive regular calls from your creditor. While it might be tempting to simply avoid these irritating calls, they represent an opportunity for you to request that the creditor forgive the debt you can’t pay.

How long does debt forgiveness take?

Once your creditor approves your request for debt forgiveness, your debt can be eliminated immediately. At that point, you’ll no longer have to make payments to that particular creditor. Be aware, however, that the forgiveness will remain on your credit report for seven years.

Pros and cons of debt forgiveness

One thing to be aware of, says Richner, is that sharing hardship information with your creditor comes with some risks. “Providing banking or employment information could make collection activity easier. This is one of the reasons this approach should only be pursued when there is a true and significant hardship rendering full or partial repayment impossible,” Richner said.

Forgiveness is rarely granted without documented proof of severe financial distress. This also opens you to potential scammers. 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.

Pros

  • Possible debt elimination
  • Reduces the time to pay off debt
  • Avoids bankruptcy
  • State-regulated fee limits

Cons

  • Tax implications
  • Scam debt relief agencies
  • Additional costs
  • Hurts your credit score

Tax implications of debt forgiveness

Any debt forgiven or settled for a savings of $600 or more is generally considered taxable income. For example, say you owe $10,000 on a credit card, and the company reduces the amount to $3,000. The $7,000 forgiven is then added to your taxable income for the year.

In some cases, you might be able to claim an exception to the burden of taking on forgiven debt as taxable income. One such example is through claiming the insolvency rule, which means you can’t pay your debt because your assets are less than your liabilities. A tax professional can help you decide if this is possible for you.

Richner suggests ways to minimize tax liability, including claiming insolvency:

  • Leverage the insolvency rule: Work with a tax advisor to document your financial situation and determine if you qualify for this exemption.
  • Plan ahead: Budget for a potentially larger tax bill by setting aside savings as soon as you learn that the debt is forgiven (or even in advance, if possible).
  • Use strategic timing: For instance, if you’ve had one debt forgiven in October, perhaps wait until January to pursue additional forgiveness to spread the tax obligation across two years.

How debt forgiveness impacts your credit score

When a creditor forgives your debt, you’ll notice a hit to your credit score. “Debt forgiveness impacts credit similarly to a settlement, with accounts often reporting a $0 balance with a remark stating it was ‘forgiven,’ ‘settled for less than the full balance’ or ‘paid in full for less than owed,’” Richner says.

While this blemish can remain on your credit report for up to seven years, there are other things you can do in the meantime to improve your score over time. Getting a handle on other debts, paying them on time and maintaining a healthier debt-to-asset ratio are all possible outcomes of debt forgiveness, and those are all positive impacts on your credit.

» MORE: Does bankruptcy clear all debt

Other debt relief options to consider

If you’re deeply in debt but trying your best to improve your credit, a few other debt relief options might have a less negative impact. For instance, negotiating a debt settlement or management plan may be more accessible with less significant tax and credit consequences. You could consolidate multiple debts into a single loan with a lower interest rate or seek guidance from a credit counseling agency to develop a structured repayment plan.

You can also try negotiating directly with a creditor. The process involves speaking with your creditor and asking for simpler payment terms that are easier to manage, like a few months’ payment relief, a lower monthly payment, a reduced balance or even a lower interest rate. Other options include transferring high-interest debt to a 0% balance transfer credit card or refinancing loans for better terms. However, debt settlement can be a far more attractive option if you’re facing bankruptcy (you’re unable to pay your debts with no relief in sight).

» COMPARE: Debt forgiveness vs. bankruptcy

Could your debt be reduced or forgiven? Take our financial relief quiz.

FAQ

Can tax debt be forgiven?

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.

» MORE: Best tax relief companies

Can mortgage debt be forgiven?

Mortgage debt is common, as many Americans and first-time homebuyers take out a mortgage to buy a home. That said, the government has historically offered assistance to those who struggle to pay it back.

  • Loss mitigation programs: These programs include forbearance planning that allows borrowers to work with their mortgage lenders to temporarily pause or reduce their monthly payments or negotiate specific repayment terms.
  • Consolidated Appropriations Act: In response to the pandemic, this excludes canceled mortgage debt through the end of 2025. This exclusion is for qualifying residents up to $750,000.

» MORE: What is preforeclosure?

How many times can debts be forgiven?

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.


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:

  1. IRS, “What if I am insolvent?” Accessed Feb. 10, 2025.
  2. IRS, “Home Foreclosure and Debt Cancellation.” Accessed March 24, 2024.
  3. IRS, “Topic no. 431, Canceled debt – Is it taxable or not?” Accessed April 7, 2024.
  4. IRS, “Offer in compromise.” Accessed April 7, 2024.
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