Debt Consolidation

Debt Forgiveness 101: Credit Cards, Student Loans and More

If you’re swamped with debt and struggling to keep up with the minimum payments, debt forgiveness can provide some relief. It’s entirely possible to have a portion of the debt you owe wiped away — and without filing for bankruptcy. Still, certain challenges and consequences come with pursuing debt forgiveness. Learn about all your options before choosing this path.

What is debt forgiveness?

When a lender forgives either part or all of a borrower’s debt — or stops that debt from growing —  it’s known as debt forgiveness. The process can be difficult to navigate and comes with several drawbacks, but some people may find it’s the best, most realistic option for them.

Debt forgiveness will vary depending on whether you’re looking for student loan debt forgiveness, credit card debt relief, mortgage loan forgiveness or tax debt relief. We’ll explain the differences below so you know how to get loan forgiveness for the type of debt you hope to clear.

Drawbacks of debt forgiveness

  • Tax consequences: In general, you’ll need to pay income taxes on forgiven debts of $600 or more. As an example, let’s say you owe $7,500 in credit card debt and agree to settle for $5,000 cash. In this case, you would receive a 1099-C tax form for the $2,500 in forgiven debt.
  • Costly fees: Debt settlement programs tend to charge upfront fees or a monthly subscription. Bankruptcy can also be expensive.
  • Potential for landing in deeper debt: If you don’t change your spending habits, debt forgiveness may not leave you better off. To benefit from lower payments or a totally clean slate brought on by debt forgiveness, you’ll need to learn to spend less than what you earn and never borrow more than you can afford to pay back.
  • Credit history impact: Most types of debt forgiveness will cause a negative impact on your credit score. This includes filing for bankruptcy, credit card debt forgiveness and seeking a short sale for your home. However, student loan forgiveness programs will not have a negative effect on your score.
  • Time-consuming paperwork: Asking for debt forgiveness usually takes both time and work — like calling all your creditors to negotiate a settlement on your own. Signing up with formal debt forgiveness programs or a debt settlement company will also take time and fortitude.

Credit card debt forgiveness

Negotiate directly with creditors

As a first step to getting out of any kind of debt, aim to negotiate with your creditors first, rather than automatically turning to a debt settlement company. (More on that below.)

With credit card debt, your card issuer may not be willing to work with you unless you can prove you’re experiencing some type of hardship. Others may be willing to forgive or reduce your debt if you simply call and explain your situation. If your debt has already been passed on to a debt collector, you’ll be expected to work with the collector instead of with your credit card issuer. A major drawback to allowing debt to go into collections is that it may also cause a big dip in your credit score.

How to negotiate with creditors

  • Call your credit card issuer and explain your hardship. You might also hint that you are considering
  • Offer to pay a lump sum to cover a portion of your debt. Start with offering to pay 15% of your debt, and negotiate from there.
  • If your creditor is unwilling to forgive your debt, ask if it has a long-term repayment plan that would decrease or eliminate ongoing interest.
  • If that doesn’t work, you could try requesting to pause or reduce payments temporarily, asking for an interest rate reduction or asking to reschedule your payment due date.
What to watch for

Working with creditors yourself may seem like a wiser and cheaper option than working with a debt settlement company, but expect potential pitfalls. For one, you will typically need to pay a lump sum to help settle your debts, and you may not have that amount on hand if you’re already struggling to pay what you owe. You’ll also need to pay income taxes on forgiven debts of more than $600. If your debt has already gone into collections, you may not be able to negotiate with creditors at all by yourself.

Wait for the statute of limitations to kick in

Debt collectors have a limited period of time — called the statute of limitations — during which they can pursue legal action against you for not paying off money you owe. The number of years will depend on the type of debt and state laws that govern your contract with the creditor; often it’s three to six years. Once the statute of limitations has ended, you will still owe the debt, but it will now be considered time-barred and the collector will no longer be able to sue you.

The statute of limitations begins when you default on a payment. However, the clock can start over if you make a partial payment on your debt. That means if you decide to make a payment on a time-barred debt, debt collectors will once again be able to take you to court. If you plan to pay off the debt, be sure to first get a signed document from the collector acknowledging that you are paying off the entire amount and releasing you from your financial obligation. Otherwise, any money you pay toward the debt might be considered a partial payment only.

How to deal with debt collectors until your debt is time-barred

  • If you don’t think you actually owe the debt, dispute it within 30 days after a first contact with a debt collector, and ask for proof of the money owed. This will stop the debt collector from contacting you until the debt is verified.
  • Send a letter to the collector asking it to stop contacting you. You have this right under federal law — just make sure your letter doesn’t also acknowledge that your debt is valid.
  • If you believe your debt is time-barred, ask for the date of the last payment. The debt collector will be required to answer you honestly.
What to watch for

If a debt collector sues you and the debt is not yet time-barred, don’t ignore the lawsuit. But if your debt is already time-barred, avoid making a partial payment on it, since this will reset the statute of limitations. Instead, you can choose to pay nothing, or negotiate an amount and get an agreement in writing that releases you from further obligation.

Sign up for a debt management plan

Debt management plans are offered by nonprofit credit counseling agencies that aim to help you get out of debt in three to five years. Although this option won’t get your debt forgiven, it could help you repay your debt for less by having fees reduced or eliminated.

With this type of plan, a credit counselor will speak with creditors on your behalf in order to potentially:

  • Lower your interest rates
  • Adjust monthly payments
  • Have fees waived
  • Stop collection calls

Although this type of debt relief program can come with a sign-up fee and monthly fee, these may be waived depending on your financial situation. Even then, your savings from completing a debt management program can outweigh the fees.

While enrolled, you’ll make payments to the credit counseling agency and may be asked to close credit card accounts, though you may keep one for emergencies. The agency will handle making payments for you.

How to sign up for a debt management plan

  • Find a nonprofit credit counseling agency. You can start your search with this list.
  • Meet with a credit counselor. They will go over your finances with you and explore possible solutions.
  • Enroll in a debt management plan, if it’s a viable option. You’ll enroll through the credit counselor assigned to help you.
  • Start making monthly payments to the credit counseling agency. During this time, you may need to close credit card accounts. Your credit counselor will handle distributing your monthly payment to creditors and negotiating with them on your behalf.

What to watch for

A debt management plan won’t have your debt forgiven, though it can reduce the fees you pay. It is a safer debt relief option compared to a debt settlement plan, as your credit counselor will actively work with creditors on your behalf. However, this type of program can come with monthly fees and your access to credit cards will be eliminated or severely reduced.

Consider debt settlement

Debt settlement companies are usually for-profit entities that work with you to negotiate down the debts you owe. But these services can be costly, damage your credit and fail to have your debt forgiven.

Debt settlement companies will typically ask you to stop paying your bills and instead start saving up a lump sum that they will use to “settle” your debts. As part of this plan, the companies require you to transfer your new savings to a jointly held escrow-like account so they can then negotiate settlement terms with your creditors. To cover their costs, the companies usually charge a hefty monthly fee that is 18% to 25% of the debt you owe.

If you’re intent on seeking debt settlement, try negotiating a settlement on your own to avoid hefty fees and potential scams.

How to negotiate your own debt settlement

  • Create a list of your debts, including creditor, amount owed and any associated interest payments or fees.
  • See how much money you have on hand. You can use this amount to negotiate a lump-sum payment that’s lower than what you owe, for example.
  • Keep detailed notes every time you communicate with a creditor. Make sure any final deal fully (not just partially) settles your debt and is in writing.
  • Be realistics. Even in a best-case situation, only 50% to 80% of your debt may get settled.

What to watch for

We recommend you avoid debt settlement programs. The debt settlement industry is rife with scammers and unmet promises. Companies in this space aren’t obligated to settle your debts, so you may end up paying costly fees and damaging your credit without getting relief. Some companies also falsely claim they will settle a consumer’s entire debt with just 30% to 60% of the total amount owed, as well, according to the Federal Trade Commission.

File for bankruptcy

Bankruptcy is a formal process that can provide borrowers with some credit card debt forgiveness, as well as relief for other types of debt. When you file for bankruptcy, your debts discharge either partially or completely.

Under Chapter 7 bankruptcy, it’s possible your debts might be forgiven entirely. With a Chapter 13 bankruptcy, however, you’ll need to repay your debt under a structured payment plan, although it’s possible to avoid having to pay the full amount on some unsecured debts, like for credit cards, medical bills and personal loans. These are debts that are not secured by some type of collateral, like a home or car.

How to get started with bankruptcy

  • Find trusted sources of legal aid. The American Bar Association and the National Association of Consumer Bankruptcy Attorneys can help you find legal help in your area. For low-income families, Upsolve is a nonprofit online service that can file for bankruptcy for free.
  • Speak with an approved credit counseling agency that can provide the counseling you’ll be required to take before actually filing for bankruptcy.
  • Decide whether Chapter 7 or Chapter 13 bankruptcy works best for you.
  • Complete the necessary paperwork and go to court to file the necessary forms.
  • Take an approved debtor education course after your file. You’ll need to complete a course before your debts are formally discharged.
  • Attend a meeting of creditors to answer additional questions. After the meeting, a bankruptcy trustee will either start selling your assets to pay off debts (Chapter 7) or a bankruptcy judge will determine if you’re eligible for a Chapter 13 payment plan.

What to watch for

Both types of bankruptcy filings will adversely affect your credit score — and the effects can be long-lasting. That’s because credit reporting agencies are legally allowed to report negative information for seven years and bankruptcy information for 10 years.

Also, with filing and attorney fees, your out-of-pocket costs for filing for bankruptcy can add up to thousands of dollars. For example, the average attorney fee for Chapter 7 bankruptcy is now around $1,500, and can run considerably more for Chapter 13 bankruptcy.

Federal student debt forgiveness

Apply for Public Service Loan Forgiveness (PSLF)

If you’re a student and have a federal direct Loan, under the PSLF program you may be able to have the remaining balance on your loan forgiven. To qualify, you’ll need to make 120 payments under an income-driven repayment plan. (If you remain on the standard 10-year repayment plan, your debt will be repaid in full before you receive PSLF forgiveness.) At the same time, you’ll need to be working full-time in a qualifying public service employment. That means working for a federal, state, local or tribal organization, or for a nonprofit.

How to apply for PSLF

  • Submit the PSLF Employment Certification Form annually or when you change jobs.
  • After making 120 qualifying payments, fill out and send the PSLF application.
  • If your application is approved, you’ll be free of both your loan principal and any outstanding interest.

What to watch for

It’s crucial to make sure you’re meeting program requirements to qualify for PSLF, so submit the certification form annually. If you’re not properly registered, it’s likely your payments won’t count toward future PSLF loan forgiveness.

Enroll in an income-driven repayment plan

For borrowers with federal student loans, income-driven repayment plans like Pay As You Earn (PAYE), Revised Pay As You Earn (REPAYE), Income Contingent Repayment (ICR) and Income Based Repayment (IBR) can ease worry about not having enough income to repay loans after graduation.

The programs let you pay a percentage of your discretionary income toward your student loans for 20 to 25 years. Once that’s done, your remaining student loan balance may be forgiven if you’re still in compliance with the program, which includes certifying your income and family size annually. If you qualify for an income-driven repayment plan and also the PSLF program, your loans might be forgiven in 10 years.

How to sign up for income-driven repayment

  • Use this federal student aid loan simulator to choose the right repayment plan for you.
  • Contact your loan servicer or visit StudentAid.gov to learn about repayment plans.
  • Submit a request for a repayment plan. You’ll do this on the StudentAid.gov website. You’ll need to provide your FSA ID, personal information like your Social Security number, and financial information.

What to watch for

As with the PSLF program, it’s crucial to make sure you are properly signed up for an income-driven repayment plan for your payments to count. However, unlike the PSLF program, income-driven repayment plans may require you to pay income taxes on any forgiven loan balance.

You should also beware of potential student loan forgiveness scams, especially if someone asks you for an upfront payment or promises quick forgiveness. In general, you should only work with your federal student loan servicer when managing your debt.

Seek loan forgiveness by occupation

Even if you don’t work in public service, your student loan may still be eligible for forgiveness relief. Specific requirements vary from program to program and are based on your state and occupation.

For example, depending on your line of work, you may be able to use the federal Teacher Loan Forgiveness Program, have your federal Perkins Loan cancelled, or receive repayment assistance by working for the National Health Service Corps. Health care providers like nurses and doctors may be eligible for certain loan forgiveness programs based on their position and location. Dentists and dental hygienists may also be eligible for forgiveness under certain state programs.

How to get started seeking loan forgiveness

  • Start your search for loan forgiveness programs by researching on the Department of Education website and organizational websites in your field. For example, StudentAid.gov features information on Perkins Loan forgiveness for teachers. The American Dental Education Association website has a list of state and federal loan forgiveness programs for individuals in the dental field.
  • Make a list of programs you may qualify for. Include information such as eligible loans, the potential amount forgiven and where to apply. This will help you stay organized. You’ll find many programs provide forgiveness specifically to individuals who work in underserved communities for a minimum number of years.
  • Work toward loan forgiveness and follow any provided instructions for applying for forgiveness. Different programs have different paperwork you’ll need to fill out, so we recommend you bookmark and save information for the specific programs you’re pursuing.

What to watch for

Like other student forgiveness programs, the programs that focus on occupation often have strict qualification requirements. For example, you may need to commit to work in a specific job or a high-need area.

Mortgage forgiveness

Apply for short sale

If you are trying to sell your home and can’t get as much as you still owe on the mortgage, one debt-saving option might be to contact your lender and apply for a short sale. With this type of sale, your lender might agree to let you sell your house for less than what you owe and forgive the remaining balance.

How to apply for short sale

  • Fill out a mortgage assistance application with your lender and provide documentation to show financial hardship.
  • Work with a real estate agent to market your home.
  • Review purchase offers with your lender.
  • Work to help close an accepted offer and transfer ownership to the new owner.

What to watch for

A short sale needs to be considered carefully; if it goes through, it will damage your credit score and may impede your ability to get a mortgage in the future. However, the damage won’t be as bad as the kind when filing for foreclosure. While foreclosure usually prevents people from getting a mortgage for seven years, individuals who go through a short sale may only need to wait two years to buy a home again.

As with other types of forgiven debts, in a short sale you’ll need to pay income taxes on the loan balance that is forgiven if that amount is over $600.

Request loan modification

Loan modification is any change that’s made to your mortgage that reduces your monthly payment, usually by decreasing the interest rate or extending the loan repayment period. Your mortgage lender may be willing to modify your loan or even forgive a portion of your debt — and you won’t need to pay taxes on the amount forgiven.

How to request loan modification

  • Contact your lender about changing one or more of the terms of your mortgage to make it more affordable. This may include a lower loan balance, lower interest rate, extended repayment term or having missed payments added to your outstanding balance.
  • Show proof of significant financial hardship. Be prepared to show proof of income and expenses, as well as your efforts to make payments.

What to watch for

Loan modification can help you avoid losing your home if payments become unaffordable. However, be prepared to pay more for the cost of your mortgage over the total life of the loan. If you miss mortgage payments either before (or possibly during) a modification, your credit score will take a big dip, as well.

Wait for foreclosure

Foreclosure takes place when you use a mortgage to buy a home but, in the end, are unable to keep up with payments. The lender can then foreclose on your home and take ownership. In general, your home loan needs to be at least 90 days’ delinquent on payments for lenders to consider foreclosure. If you’re considering a foreclosure, proceed with care. Sure, you’ll be able to have your mortgage debt forgiven — but you’ll also lose your home.

How the foreclosure process works

  • Your mortgage lender will start the foreclosure process, usually three to six months after you miss your first payment.
  • The lender issues public notices to all parties that the foreclosure process is starting.
  • You are given an established period of time to make a payment.
  • If you continue to default, your home will be sold at auction. The timeline and process for foreclosures can vary by state.

What to watch for

Foreclosure doesn’t actually mean your loan goes away. Your lender still has the right to try to collect the balance of your home loan until you file for bankruptcy and include your home in your bankruptcy proceedings. Another downside of foreclosure (and potential bankruptcy) is that it will damage your credit for years. Going through foreclosure will also make it harder to get a home loan for up to seven years.

Tax debt forgiveness

Apply for an Offer in Compromise

The Internal Revenue Service offers an official way for individuals who want to have their tax debt forgiven or delayed; it’s called the Offer in Compromise (OIC) program. An OIC lets you settle your tax debt for less than the full amount you owe, and it might be a legitimate option if you’re unable to pay your full tax bill or if doing so would create a financial hardship.

The IRS considers the following factors when determining eligibility for an OIC:

  • Ability to pay
  • Income
  • Expenses
  • Asset equity (the value of your assets after financial obligations like loans are taken into account)

The agency typically approves OICs when the amount offered represents the most it can expect to collect within a reasonable period of time.

How to apply for an OIC

  • Check to see if your debt qualifies by visiting the IRS website and filling out this form.
  • Complete the necessary paperwork in this OIC booklet.
  • Submit your application with a $205 application fee and an initial payment offer (you are exempt from this step if you meet certain low-income certification guidelines).

What to watch for

An application for an OIC doesn’t necessarily mean you’ll get approved for the program. If you don’t get a go-ahead, you may still be able to appeal within 30 days of receiving a rejection. If you are approved, you will need to come up with a lump sum of cash, followed by periodic payments to pay off your agreed debt settlement. Any refunds due to you in the year your OIC is accepted will be withheld and applied to your tax debt. In other words, if you’re used to getting a large tax refund, you can expect it to disappear in the year you settle your tax debt.

 

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