Debt Forgiveness

Debt forgiveness summary: 

• Debt forgiveness typically follows a negotiation to reduce the amount of debt you owe.

• Debt forgiveness is generally only effective with unsecured debt.

• You could get part of your debt forgiven if you can prove a genuine financial hardship and show you’re willing to pay as much as you can.

Debt Forgiveness Definition and Meaning

Debt forgiveness involves a signed agreement specifying the amount forgiven and the amount you'll pay. Once you have that agreement and you satisfy your part of it, the debt is cleared and you don’t owe the creditor anymore. Collection efforts stop.

Debt forgiveness is a reduction in the amount of debt owed. Debt forgiveness is typically an outcome of debt negotiation or special federal student loan repayment plans.

Common Characteristics of Debt Forgiveness

Debt forgiveness typically involves a series of steps and requests.

Generally, you’ll have to request forgiveness. Creditors are unlikely to offer debt forgiveness without being asked for it. You can negotiate debt forgiveness yourself, or hire a professional debt settlement company to negotiate with creditors on your behalf. 

You’re more likely to be granted partial debt forgiveness if you can demonstrate a genuine financial hardship. If it’s clear that you have no realistic way of paying the full amount, your creditor might be willing to be flexible. After all, it’s better to get something than nothing. It costs money to sue people for unpaid debts. It could be in the creditor’s financial best interest to accept a lower amount to satisfy the debt.

Forgiven debt could be considered taxable income. (If you’re insolvent when you settle a debt, the forgiven amount may not be subject to income taxes.) Insolvent means the total of what you owe is greater than the total value of what you own. It’s a good idea to talk to a tax professional about your situation before you ask for debt forgiveness.

Types of Debt Forgiveness

Forgiveness is typically available only for unsecured debt. That’s because secured debts are tied to collateral. Collateral is something valuable that the lender can take and sell to recover the money you owe. 

For example, if you don’t pay your car loan, your lender could repossess your car and sell it. Lenders generally don’t offer partial forgiveness of secured debts. If you can’t repay the debt, the typical course of action would be to sell the collateral and pay off the debt.

Some common forms of unsecured debt that could be eligible for partial debt forgiveness are:

• Credit card debt

• Medical debt

• Unsecured personal loans

• Private student loans

Federal student loans have formal programs you could use to have some of your debt forgiven under certain conditions. For other forms of debt, standard programs aren’t available. Forgiveness must be negotiated on a case-by-case basis.

Debt Forgiveness: A Comprehensive Breakdown

Here’s how debt forgiveness works:

• Identify which of your debts are unsecured and could be eligible for forgiveness.

• Decide whether to handle negotiations yourself, or hire a debt relief professional to do it for you.

• Figure out how much of your unsecured debts you can afford to pay. 

• Be prepared to provide details and documentation about your financial situation.

• Explain what unforeseen circumstances led to you being unable to pay your debts.

• Get any settlement agreement in writing before you send a payment.

Real-Life Examples of Debt Forgiveness

The type of debt will determine how debt forgiveness can work. For example, federal student loans will be handled differently from credit card debt.

Credit card debt forgiveness

Calvin had an injury that left him with high medical bills and unable to work. Before the injury, he had $6,000 in credit card debt. Now he’s struggling to make his rent and utility payments. He can’t afford to fully pay off the debt and cover all of his other expenses.

He negotiates with the credit card company to accept $2,000 as payment in full for the credit card debt. Calvin has no other resources and won’t be able to return to work any time soon. If they sue him for the debt, the credit card company might not recover the full $6,000. Plus they’ll incur legal and court costs. They recognize that the $2,000 might be their best financial option.

Student loan debt forgiveness

Estelle has been paying off her student loans for 20 years. Under a federal student loan income-based repayment (IBR) plan, she can afford her payments. However, because her income is low, those payments haven’t made much of a dent in her debt. 

Under the terms of her IBR plan, she could be eligible to apply to have the remainder of the debt forgiven. If the U.S. Department of Education is processing loan forgiveness and Estelle has made all of the payments required by her plan, her partial debt forgiveness could be processed automatically, with no additional steps on her part.