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Debt Forgiveness: The Options & Consequences

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In a Nutshell

Debt forgiveness is when one of your lenders forgives or erases some or all of your debt. This debt could be from a credit card, a student loan, or an installment loan. Sometimes you can get a full debt forgiven, but more often, you’ll get partial forgiveness. For example, if you come to a debt settlement agreement with a credit card company, you agree to pay part of your outstanding debt in exchange for having the rest of the debt erased. With many student loan forgiveness programs, you must pay a portion of your debt for a certain period of time before you get the remaining balance forgiven.

Written by Attorney Tina Tran
Updated June 28, 2023


What Is Debt Forgiveness & How Does It Work?

Debt forgiveness is when one of your lenders forgives or erases some or all of your debt. This debt could be from a credit card, a student loan, or an installment loan. Sometimes you can get a full debt forgiven, but more often, you’ll get partial forgiveness. For example, if you come to a debt settlement agreement with a credit card company, you agree to pay part of your outstanding debt in exchange for having the rest of the debt erased.

Debt forgiveness isn’t always easy to come by. Usually, lenders that offer loan forgiveness programs have eligibility requirements. To determine whether and how much of your debt to forgive, your lender will consider your financial circumstances and how much debt you owe. 

Debt forgiveness is usually available for unsecured debts like credit cards, personal loans, or student loans. Secured debts like a mortgage or a car loan are not usually eligible for debt forgiveness. If you default on a secured debt, the lender will likely pursue foreclosure or repossession. If you are having difficulty paying the minimum payments on your secured debts, you should look at options like loan modification, a forbearance agreement, refinancing, or bankruptcy.

How Do You Get Debt Forgiveness?

Some people can get debt forgiveness by directly contacting and negotiating with their lenders. Other people prefer to hire a credit counselor, debt settlement company, or debt relief agency to help them manage their monthly payments, negotiate debt settlement agreements or lower interest rates, or get a debt consolidation loan.

When it comes to federal student loan debt relief, StudentAid.gov has the latest information on student loan forgiveness programs. The status of the student loan forgiveness plan and repayment options for federal student loans changes frequently. So pay attention to the news or subscribe to the U.S. Department of Education’s email list to stay caught up on the latest developments that could affect your student loans.

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What Are the Pros and Cons of Debt Forgiveness?

Debt forgiveness can help relieve financial stress and may be the ticket to shoring up your finances. But it can be difficult to get and has some consequences you’ll want to consider. 

Also, when it comes to debt relief of any kind, be aware of scams. Scam phone calls for student loan debt forgiveness have been on the rise in recent years, and several unreputable companies try to make money off people seeking debt forgiveness for credit card and other debt.

The Benefits of Debt Forgiveness

You can probably guess the biggest benefit of debt forgiveness: You no longer have to repay what was probably a quite burdensome debt. Even if you agree to a debt settlement and only have part of your debt forgiven, you benefit by paying less than the total amount you owed. 

Getting into debt can become a vicious cycle. If you’re struggling to repay one debt, odds are good that there are other debts you’re trying to manage as well. Having one debt forgiven can free up the resources to pay down other debts, avoid debt collection, or get on the path to becoming debt-free. If you have a debt management plan, debt forgiveness can expedite your plan and help you pay off your debt even sooner than expected.

The Downsides of Debt Forgiveness

As with most things in life, debt forgiveness has some downsides. You may see a dip in your credit score or have a bigger tax bill.

Your Credit Score May Drop as a Result of Debt Forgiveness or Settlement

Depending on the type of debt and type of forgiveness, you may see your credit score drop as a result. The lender or creditor agreeing to the debt settlement or forgiveness will likely report this activity to the major credit bureaus. Your account may be annotated as “settled” or “settled for less than the full balance.” Both of these are considered negative entries because they signal that you did not repay your debt on time and in full as agreed. 

That said, the damage may already be done here. Most lenders won’t agree to forgiveness or settlement until you’ve defaulted on your debt. That means by the time you come to the negotiating table, your credit score has likely already taken a serious hit. Learn more by reading our article How Debt Settlement Affects Your Credit Score.

Debt Forgiveness May Raise Your Taxable Income

Debt forgiveness may also have some tax consequences. The amount that’s forgiven will be counted as income on your upcoming tax return, which means you may have to pay income tax on it.  

Some Student Loan Forgiveness Programs Don’t Have These Negative Consequences

There’s one important caveat here. Student loan debt forgiveness programs like the popular Public Service Loan Forgiveness (PSLF) program, Teacher Loan Forgiveness, and Total and Permanent Disability Discharge do not come with these negative consequences. Participating in any of these forgiveness or cancellation programs will not negatively impact your credit score, and you won’t be responsible for paying taxes on student loan debt forgiven through the program.

However, if you participate in a 20–25-year income-driven repayment program, any amount forgiven at the end of the payment period will be considered taxable income and may come with a sizable tax bill.

What Are the Different Types of Debt Forgiveness?

There are as many debt forgiveness options as there are types of debt! You may be able to find debt forgiveness programs or options for credit card debt, student loan debt, medical debt, tax debt, and more.

You may qualify for special debt forgiveness programs if you:

  • Are a low-income individual

  • Are on permanent disability

  • Have been affected by the coronavirus pandemic

  • Are a full-time student

  • Work in a qualifying occupation

Here’s more information about common types of debt forgiveness.

Student Loan Debt Forgiveness Options

Student loan forgiveness is a hot topic these days. Most people are familiar with the pandemic-related student loan repayment pause and the Biden administration’s proposed forgiveness plan. With the payment pause sunsetting by October 2023 and Biden’s forgiveness plan still under review by the Supreme Court, you may be wondering if student loan borrowers are left with any forgiveness options.

The good news is that several student debt relief options ]have continued outside the political chaos of Biden’s student loan forgiveness proposal.

The most popular and widely used program is the Public Service Loan Forgiveness (PSLF) program. To be eligible, you must work for a qualifying nonprofit or government organization. 

Student loan borrowers who participate in income-driven repayment plans are also eligible to have their remaining loan balances forgiven after the 20–25-year repayment period. Income-based repayment is also a great way to get a more manageable student loan payment since it’s based on your discretionary income and household size (instead of the length of the loan).

How Does Student Loan Forgiveness Work?

Student loan forgiveness works like ordinary debt forgiveness (sometimes called debt cancellation when referring to student loans), but it’s specific to federal student loans issued by the U.S. Department of Education. It doesn’t apply to student loans issued by private lenders like banks. 

Credit Card Debt Forgiveness Options

Credit card issuers and lenders are not as willing to negotiate debt forgiveness as you might hope because they have several debt collection tools. That said, credit card debt forgiveness is not impossible — especially if your debt has already been deemed uncollectible and you decide to pursue the path of debt settlement

For example, you might offer to pay 50% of the outstanding debt you owe in one lump sum. If your lender accepts this offer, the remaining 50% of your debt will be forgiven. Again, beware that this may lower your credit score and have tax consequences.

If you want to learn more, check out our article on 5 Solid Steps for Negotiating With Debt Collectors.

Don’t Qualify for Debt Forgiveness? Consider Filing for Bankruptcy

If you feel like you’ve tried everything and just can’t get ahead, you may want to look into filing for bankruptcy

In Chapter 7 bankruptcy, most of your debts are erased, and you get a fresh start. You can even have federal Direct Loans discharged in bankruptcy if you meet eligibility requirements. Upsolve offers many resources for bankruptcy including a free online filing tool and access to a free consultation with a private attorney.

Let’s Summarize...

Debt forgiveness can be a great tool in the right circumstances. For credit card debt, lenders may require you to pay part of the debt, then forgive the rest. Debt forgiveness can relieve financial stress, but keep in mind your credit score may suffer and your tax bill may increase. 

Thankfully, student loan forgiveness programs (except for forgiveness following the completion of an income-based repayment plan) don’t come with these same negative consequences. To help with the federal student loan debt crisis, the U.S. Department of Education offers several loan forgiveness programs that only apply to federal education loans.



Written By:

Attorney Tina Tran

LinkedIn

Tina Tran is the managing bankruptcy attorney for Upsolve, the largest consumer bankruptcy non-profit in the United States. She received her Juris Doctorate degree and Certificate in Advocacy from Loyola University Chicago School of Law. She is licensed to practice law in Illinoi... read more about Attorney Tina Tran

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