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Debt Forgiveness 101: Credit Cards, Student Loans and More
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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, so be sure to learn all your options before choosing this path.
Let’s take a look at the following topics:
How debt forgiveness works
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.
Student loan debt forgiveness
With the average amount of student loan debt at $29,900, and, in some cases, much higher, can seem like an overwhelming financial challenge to overcome. Below are several routes you can take to pursue debt forgiveness for your student loans.
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.
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.
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 canceled, 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.
Tax debt forgiveness
You may be surprised to find that even tax debts may be eligible for debt forgiveness. Here’s how you can help alleviate your outstanding tax debts.
Apply for an Offer in Compromise
The Internal Revenue Service (IRS) 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
- 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.
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.
Mortgage debt forgiveness
Similar to student loans, federally funded mortgage debts typically have more options around debt forgiveness compared to private loans. Here are several ways to pursue debt forgiveness for your home payments.
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.
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.
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.
Credit card debt forgiveness
Credit cards are typically an unsecured form of credit with interest rates that reach as 29.99% or higher. As a result, as interest compounds as you start to rack up debt, your monthly payments can start to go up quickly. Here are some options if you find yourself unable to keep up with your credit card debt.
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.
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.
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.
Pros and cons of debt forgiveness
Benefits of debt forgiveness
- Avoid bankruptcy: Debt forgiveness can help you to avoid having to file for bankruptcy. Not only can bankruptcy stay on your credit profile for seven to 10 years, but the fees and costs involved can be expensive. Having bankruptcy on your credit history can make it hard for you to qualify for lines of credit down the road, or at least until it comes off your credit profile.
- Pay less on your debt: Depending on which debt forgiveness program you are eligible for, you may be able to pay a much smaller percentage of your debt than you originally owed. This may save you more money in the long run and provide much needed financial alleviation.
- Pay debt in less time: Though it can depend on what kind of debt forgiveness plan you qualify for, this approach to your debt may also allow you to cut down or even eliminate your debt in much less time than you were originally anticipated to. Paying off your debts in less time may also help you to save money.
Drawbacks of debt forgiveness
- Tax consequences: In general, you’ll need to pay income taxes on forgiven debts. 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.
- 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.
Alternatives to debt forgiveness
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. 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.
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 15% 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.
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. It is 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.
Explore all your options
If you reach a point in your life where you’re no longer able to pay back your debt, there are still a plethora of options at your disposal. Unfortunately, some of these options may take a toll on your credit, though it may help to preserve at least some of your finances.
Whenever you are faced with a decision like this, be sure to research and educate yourself on all your choices in order to avoid even more fees and further damage to your credit profile. If you find yourself unsure of what your next steps should be, consider reaching out to a debt counselor.