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What is debt forgiveness?

Plus, how to qualify for debt forgiveness

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by Jessica Render ConsumerAffairs Research Team
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Debt forgiveness is when a creditor forgives some or all of your outstanding balance, whether your debt is from credit cards, federal student loans, taxes or a mortgage. To receive debt forgiveness, you typically have to apply for or qualify for a forgiveness program. Your debt forgiveness options vary based on the type of debt you have. Total debt forgiveness is rare, and a more common forgiveness option is debt settlement that forgives a portion of your debt.

How does debt forgiveness work?

Depending on the type of debt you have, you may qualify for total debt forgiveness or a partial debt forgiveness option that makes your debt easier to manage. With debt settlement, you hire a company to negotiate a one-time, lump-sum payment with your creditors for less than the amount you owe.

Debt settlement is ideal for people with more than $10,000 of unsecured debt from medical bills, utility bills or credit cards. The process usually takes two to four years, and it may lower your credit score initially.

However, sometimes a debt settlement company is unable to reach an agreement with your creditors. In that case, you still have to pay off your entire original debt amount and any fees you might owe to the debt settlement company. Secured debts, such as car loans and mortgages, are not eligible for debt settlement.

You might consider filing for bankruptcy. Filing for bankruptcy may discharge some or all your debts, including medical bills, unsecured loans, credit cards and utility bills. Depending on the type of bankruptcy you file for, you may have to forfeit some of your possessions or still repay your debts over time. Bankruptcy can send your credit score plummeting up to 200 points and stay on your credit report for seven to 10 years, so it’s often a last resort.

Creditors can not take you to court to enforce a debt past the time specified by the statute of limitations where you live. The statute of limitations varies by state and ranges from three years to 10 years. The age of your debt starts from the last time you made a payment on it. Each time you make a payment, the statute of limitations restarts.

A creditor can legally enforce a debt within the statute of limitations, however. Even if a debt is no longer enforceable, it stays on your credit report for at least seven years and can impact your credit score.

How do you qualify for debt forgiveness?

The qualifications for debt forgiveness vary based on the type of debt you wish to have forgiven. You may also need a specific amount of debt if you choose to work with a debt settlement company —  some may require their clients owe a minimum debt of $7,500 to $10,000.

Credit card debt forgiveness

Credit card debt does not typically qualify for total debt forgiveness. However, you might be able to get some of your credit card debt forgiven. To do so, you would hire a company to negotiate a lump-sum debt settlement that’s less than the amount you currently owe. Your credit card company is unlikely to forgive all of your credit card debt, but it may forgive some of it if you can reach an agreement.

Student loan forgiveness

While student loans issued through private lenders do not qualify for debt forgiveness, federal student loans often do. To have federal student loan debt forgiven with no consequences, you have a few options.

The Public Service Loan Forgiveness (PSLF) program through the U.S. Department of Education requires you to make 120 qualifying monthly payments, or 10 years of payments, under a qualifying repayment plan while you work full-time for a qualifying employer, including the government and not-for-profit organizations.

Another option is to sign up for income-driven repayment. With the income-driven payment plan, your federal student loans are forgiven after 25 years of payments.

Mortgage debt forgiveness

Mortgage debt forgiveness is rare, but you may be able to reduce the principal amount you owe or modify your mortgage loan and get more favorable terms, such as lower monthly payments, through refinancing. Your options vary by your financial standing and lenders. You can work with a major lender to modify your mortgage, or you can go through the Federal Housing Administration (FHA) if you have an FHA-insured mortgage. Call the FHA or the Homeownership Preservation Foundation to find out if you’re eligible.

Tax debt forgiveness

Tax debt may qualify for partial debt forgiveness. You have two options through the IRS Fresh Start Program: an extended installment agreement or an offer in compromise (OIC). Your specific tax situation dictates what payment arrangements are available to you, but you may qualify for an extended installment agreement where you make monthly payments and don’t accrue additional penalties or interest on your tax debt.

With OIC, you might be able to settle your tax debt for less than the full amount you owe. To qualify for an OIC, you must be unable to pay your federal tax debt in full or be experiencing a financial hardship that prevents you from paying your tax debt. Take the IRS offer in compromise prequalifier quiz to find out if you qualify for an OIC. If you qualify, a certified tax professional can help you negotiate an OIC.

What are the consequences of debt forgiveness?

The consequences of entering a debt forgiveness program depend on the type of program, but typically any forgiveness program lowers your credit score until your initial debt is paid off. Debt settlements especially impact your credit score negatively since they stay on your credit report for up to seven years. In addition to paying a portion of your debt, you have to pay your debt settlement company for negotiating your settlement. Sometimes companies can’t reach an agreement with your creditors, so you’re stuck with the full bill and their fees.

Your forgiven debt may also be considered taxable income by the IRS. After a debt is canceled, forgiven or settled, your credit should send you a form 1099-C Cancellation of Debt document showing your total canceled debt. The IRS requires you to report this canceled debt amount on your tax return using Form 1040 and treats it as taxable income. Certain exceptions do apply, including, but not limited to, the following:

  • Amounts canceled as gifts, bequests, devises or inheritances
  • Student loan debt canceled due to specific loan provisions, like working in a certain profession for a certain period of time
  • Student loans discharged due to death or disability
  • Reduction of the principal balance of your home mortgage under the Home Affordable Modification Program
  • Debt canceled in a Title 11 bankruptcy case
  • Debt canceled to the extent insolvent

What other debt relief options are there?

If debt forgiveness isn’t possible, you can choose to go with an alternate debt relief option to get your debt under control. Debt consolidation is a common option when you can’t keep up with payments or the amount you owe is snowballing because of high interest rates. Under debt consolidation, you typically take out one loan with a lower annual percentage rate or more favorable terms to pay off your existing debt. You typically need a credit score of at least 580 to qualify for a debt consolidation loan.

You can also work with a credit counselor to create a debt management plan (DMP). With a DMP, you can consolidate your monthly payments and potentially lower your interest rates. Plus, your credit counselor can help keep you accountable for sticking to your plan and making on-time payments.

Additionally, you can contact your creditors and possibly work out a payment plan so that your monthly payments are more manageable for your financial situation. You can also try to negotiate a lump-sum payment to pay off your debt without the assistance of a debt settlement company.

Bottom line

Debt forgiveness can seem like an attractive option when you’re struggling with debt, but, as with most financial decisions, there are pros and cons. We recommend looking at all your options, including debt repayment strategies such as the popular avalanche, snowball and blizzard methods. If you are struggling to deal with your finances, you are not alone and there are resources available to you, including debt forgiveness.

If you’re not sure what debt relief option is best for you, we recommend getting advice from a certified credit counselor.

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    Profile picture of Jessica Render
    by Jessica Render ConsumerAffairs Research Team

    As a member of the ConsumerAffairs research team, Jessica Render is dedicated to providing well-researched, valuable content designed to help consumers make informed purchase decisions they can feel confident making. She holds a degree in journalism from Oral Roberts University.