How Debt Forgiveness Really Works
11 MIN READ
Published April 06, 2023 | Updated October 02, 2023
If you are struggling with unmanageable debt and think you’ll be unable to pay everything off, debt forgiveness programs can be a viable option. Just be sure to understand the pros and cons of these programs before you decide to apply for one.
Trying to pay off large debts can feel like a never-ending process. Those who are dealing with high-interest-rate debts may feel even more disheartened.
Although repaying what you borrowed along with the interest charges is difficult, there are other debt relief solutions available to you. Whether you faced financial hardship due to the pandemic or unemployment, there are several ways to tackle debt.
Debt forgiveness can lighten the burden of your debt as long as you make an informed choice. This is an appealing option that, unfortunately, attracts a lot of scam artists. Do your research to avoid potential pitfalls.
Let’s explore a few debt forgiveness programs that you may be able to take advantage of.
What is Debt Forgiveness?
Debt forgiveness is when a lender forgives some or all of the outstanding balance on your loan. Lenders are in the business of making money, so they won’t erase your balance just because you ask.
For a creditor to offer you debt cancellation, you will have to qualify for the program. Many of these rules can be difficult to qualify for, but there are other debt relief options available.
Debt forgiveness can also come in other forms, such as waiving off part of your outstanding balance through debt settlement.
How Does Debt Forgiveness Work?
When a lender releases you from the responsibility to repay some or all of the debt, you no longer need to worry about repaying that forgiven debt. There are many forms of debt forgiveness, and each works in a different way.
In any scenario where you don’t make a full repayment towards the money you borrowed, the remaining balance is considered to be forgiven debt.
Theoretically, almost any type of debt can be partially or fully forgiven. But it is entirely up to your lender to decide whether this happens or not.
For a lender to forgive the debt, it has to be in their best interests. This means that if you can repay your debt, it is very rare for your lender to forgive your debt.
How Do I Know if I Qualify for Debt Forgiveness?
Each debt forgiveness program has different qualification requirements. If you are struggling with student loan payments, you may qualify for federal student aid.
For student debt relief programs, requirements include having a particular type of loan or being in specific public service occupations.
If you have credit card debt and are interested in applying for a settlement to be discharged from some of your debt, it is best to consult a debt settlement company.
A debt relief consultant will gather your information, such as your expenses, income, liabilities, and assets. Based on this information, they will provide you with the best debt forgiveness option available to you.
Types of Debt Forgiveness
There are several types of debt forgiveness options available based on the type of debt you currently have. Let’s explore some of the most common types of debts that may be eligible for forgiveness.
Student Loan Debt
Student loan forgiveness programs are not easily accessible. Your options will depend on factors such as how much you owe, your occupation, income, and the type of loan you have.
Most programs are available to those working in specific public service or education professionals. In very rare cases, it may be available for bankruptcy.
The eligibility rules are quite strict, which makes it difficult for most student loan borrowers to get rid of their student loan debt.
Not all types of federal student loans are eligible. Loans that are eligible are mainly Perkins loans, direct loans or Stafford loans, and Federal Family Education Loans.
The supreme court has still not reached a decision on President Joe Biden’s student loan forgiveness, but the pause remains in effect.
Some repayment plans are also available through the U.S. Department of Education that may include forgiveness or cancellation of a part of their debt.
It is also important to remember that any debt that is erased is considered to be income and comes with an IRS tax bill.
If you are facing financial hardship, you may be eligible for a medical debt forgiveness plan. Many healthcare service providers offer forgiveness programs if you meet the eligibility requirements.
You may have to provide documents like tax returns to prove that you have no means to pay off your outstanding bills.
Non-profit organizations such as Patient Advocate Foundation and CancerCare also offer financial assistance to Americans facing hardship. Another option is to check if your healthcare provider offers an income-driven hardship plan.
Those with low income may be eligible for financial assistance through these programs. In many cases, you may receive medical debt forgiveness through charity care.
You’ll first have to apply for Medicaid before you can apply for an income-driven repayment program.
To qualify for IRS tax forgiveness, you’ll have to be in a really tough financial spot. Offer in Compromise is one way to get your tax debt forgiven. The only way to qualify for the program is if you are nearly insolvent and have almost no assets.
The IRS has several means to collect from taxpayers by putting a lien on your account, revoking your passport, selling your property, collecting part of your social security check, and holding your refund.
Offer in Compromise will only be accepted by the IRS if it believes there is no way to collect the money you owe.
When you apply for the program, you must pay a non-refundable fee. You must also pay 20% of the total offer amount when sending your application.
In most cases, it is better to apply for an installment plan with the IRS if you have trouble paying your tax bills.
There are a number of programs available to FHA-insured homeowners at risk of foreclosure. If you are facing financial hardship, you can contact your mortgage provider to see if you are eligible for loss mitigation options.
If you qualify for the Home Affordable Modification Program, you may be eligible to reduce a portion of your total outstanding balance and your monthly payments.
Typically, mortgage debt forgiveness will be a last resort option for your lender. Unless they consider you to be insolvent, it will be difficult to qualify for one of these programs.
If your mortgage is unaffordable, it might be better to consider refinancing or ask for a temporary payment pause to reduce some of your burdens.
Credit Card Debt
If a credit card issuer believes that borrowers have no means to pay the outstanding balance or that they may file for bankruptcy, they may accept a settlement offer and forgive the remaining debt.
With debt mediation or debt settlement, a portion of your debt can be forgiven, and you may be able to save up to 50% of your debt before fees.
Filing for chapter 7 bankruptcy is another way of resolving your unsecured debts, such as credit card balances.
A bankruptcy filing can end garnishments and erase debts legally. Bankruptcy is an extreme measure, but if you have little to no assets, it may be right for you.
Advantages and Drawbacks of Debt Forgiveness
While the main advantage of debt forgiveness is that you have to repay less, there are a few other advantages that you should consider.
- With debt forgiveness, you will not have to worry about missed or late payments. Having less debt overall will also have a positive impact on your credit utilization.
- You will not be responsible for the forgiven amount once you are relieved from it. This means that your lenders won’t come after you to collect debts.
- Any forgiven amount is considered to be taxable income. You are required to report any canceled debt on your income tax returns. If you have a considerable amount of forgiven debt, you will have a large tax bill to pay.
- There are several dishonest agencies that prey on people facing financial hardship. Be wary of shady practices and agencies charging a lot of money to help you qualify for a debt forgiveness program.
Alternatives to Debt Forgiveness
Debt forgiveness programs are difficult to qualify for because of the stringent criteria. There are several other debt-relief options available to consider.
If you need help repaying your debts, a credit counseling agency can enroll you in a debt management plan.
Usually, this involves setting up a plan where you make a single monthly payment. This will then be distributed towards all your debts.
Your credit counselor may also be able to negotiate with your lenders to lower your interest rate or waive fees or penalties.
Enrolling in a program means you will usually be restricted from opening any new credit cards or lines of credit.
The long-term effects of establishing financial responsibility and paying off your debts are well worth the short-term sacrifices.
You can apply for a low-interest debt consolidation loan or a 0% balance transfer credit card if you have a good credit score. You can then consolidate all your high interests debts into a single monthly payment.
One of the biggest benefits of debt consolidation is that it will allow you to reduce your overall costs by replacing your high-interest debt with a new low-interest loan.
Compare the interest rates offered by different lenders to find one that will allow you to save the most.
If you have a lot of debt and are not able to pay it all off, debt settlement is a viable option. A debt relief company will negotiate with your loan servicer to settle your account for less than you owe.
Once you reach a settlement and pay the agreed lump sum, your account will be closed, and the remaining debt will be forgiven.
This is a good option for those with missed payments, late fees, and debts in collection.
Typically, debt settlement will take 24-48 months to complete and will allow you to save up to 50% of your total debt before fees.
Debt forgiveness can provide you some reprieve from your financial burden by erasing some or all of your debt if you are eligible.
Even if you are not eligible for these programs, there are many other debt relief programs available to help you regain control of your finances.
At TurboDebt, we can help you find the right debt relief program with our counseling, consultation, and planning services.
Connect with our debt relief professionals for a free consultation today.