What is Debt Forgiveness?
If your debts are keeping you up at night and you’re struggling to make your minimum payments, debt forgiveness can provide some relief.
Having a lender wipe out part — if not all — of your debts clean so you don’t have to file for bankruptcy might sound too good to be true. But this option isn’t intended to be a get-out-of-jail-free card and may come with certain conditions you’ll need to meet to be eligible. Be sure you fully understand both the benefits and drawbacks before choosing this option to manage your debt.
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How does debt forgiveness work?
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.
To apply for debt forgiveness, start by speaking to your lender. They may offer special hardship programs. If you meet the eligibility requirements, your lender may forgive either a portion or the entirety of the outstanding balances on your unsecured debt, potentially including credit cards, personal loans or medical bills.
Debt forgiveness programs and their conditions vary by the type of forgiveness you’re looking for. Whether you’re applying for student loan debt forgiveness, credit card debt relief, tax debt relief or mortgage loan forgiveness, it’s important to know how to apply and the eligibility requirements.
Types of debt forgiveness
Just as each type of debt is unique, so are the various forms of debt forgiveness. Here’s what you need to know about each type:
Student loan debt
While the Biden administration’s student loan forgiveness plan is on hold until approved by the Supreme Court, there are other options for borrowers with federal student loans.
If you have a federal direct loan and work full time for a nonprofit or in a public service field, you might be able to have the remaining balance on your student loan forgiven under the Public Service Loan Forgiveness program. To qualify, you’ll need to make 120 payments under an qualifying income-driven repayment plan while working full time for a federal, state, local, tribal or nonprofit organization.
If you’re a teacher employed by a qualifying school, you can apply for the federal Teacher Loan Forgiveness Program, which forgives up to $17,500 in Stafford loans, or have 100% of your federal Perkins Loan canceled through Perkins Loan Teacher Cancellation. Repayment assistance could be an option if you work for the National Health Service Corps, and if you’re a health care provider, dentist or dental hygienist, you may qualify for forgiveness under certain state programs.
You may also consider seeking student loan forgiveness through an income-driven repayment plan. Income-driven repayment limits your monthly repayment to a hopefully affordable percentage of your disposable income, and then after 20 or 25 years (depending on which program you’re on), you’ll have the remainder of your debt balance wiped away for good. (Notably, the forgiven amount could be tax-free through 2025 or longer.)
Tax debt
If you can’t pay your tax bill — or are able to demonstrate that doing so would create financial hardship — you could apply for tax relief in the form of a payment plan. The IRS offers both short-term and long-term plans, depending on how much you owe in taxes.
Another option is to file an Offer in Compromise. An OIC isn’t exactly debt forgiveness, but it does allow you to settle your tax debt for less than the full amount you owe. While applying for an OIC won’t cost you anything, it also doesn’t guarantee approval. Your eligibility will be determined by several factors, including your income, expenses, assets and ability to pay.
If your OIC request is rejected, you have 30 days to appeal the decision. Once approved, you’ll need to come up with a lump sum of cash, followed by periodic payments to pay off the agreed debt settlement. Note that any tax refunds you might be expecting will automatically be applied to your debt.
Medical debt
If you’re overwhelmed by medical bills, consider speaking with your provider or hospital about their financial assistance policy and whether they can extend any forgiveness options. Nonprofit hospitals — which account for more than half of all hospitals in the U.S. — are required by law to extend financial assistance or charity care to low-income patients. You may need to write a letter explaining your personal situation and include some documentation to verify your income.
To reduce the impact of medical debt, credit bureaus Equifax, Experian and TransUnion recently announced that medical collection debt under $500 will no longer appear on credit reports and paid medical collection debt will be removed altogether.
Credit card debt
In late 2022, the Federal Reserve reported that Americans owe a whopping $986 billion in credit card debt. While you won’t find a dedicated forgiveness program for credit card debt, you may consider debt settlement if you’re ineligible for bankruptcy and unable to keep up with minimum payments. A debt settlement company may be able to negotiate with your creditors on your behalf to reduce your debt, though there’s no guarantee that your creditors will agree to your request.
However, the debt settlement process can take time and won’t shield you from collection calls, further damage to your credit score or potential legal action against you. If you can’t negotiate a reduction in your credit card debt, you may want to consider credit card refinancing, which can make repayment more manageable.
Mortgage debt
While consumers saw substantial forgiveness programs in place during the housing crisis of 2007, lenders have since tightened their lending standards. While mortgage forgiveness is unlikely, you do have a few options.
If you’re trying to sell your home and can’t get as much as you still owe on the mortgage, you can contact your lender and apply for a short sale. Your lender might agree to let you sell your house for less than what you owe and forgive the remaining balance. Another option is to ask for a mortgage modification to lower your monthly payment through a reduced interest rate or or a longer repayment term.
Finally, the least palatable option is foreclosure, the process a lender uses to take over ownership of your home in the case of loan default.
Pros and cons of debt forgiveness
While debt forgiveness may sound like a magical solution to all your financial woes, it can come with downsides, such as having to pay taxes on the amount of debt forgiven or taking a hefty hit to your credit score. Before pursuing debt forgiveness, weigh the pros and cons to determine whether it’s the best option for you.
Benefits of debt forgiveness
Avoid bankruptcy: The upside of debt forgiveness is that it can help you avoid having to file for bankruptcy. Bankruptcy can stay on your credit history for seven to 10 years and will identify you as a high-risk borrower, making it harder for you to qualify for loans and lines of credit in the future. The extra fees associated with bankruptcy can make it an expensive process.
Repay your debts sooner: Debt forgiveness can allow you to cut down or even eliminate your debt in much less time than you were originally anticipating. Paying off your debts more quickly can help you save money in the long run.
Pay less than what you originally owed: While it depends on the type of debt forgiveness program you qualify for, you could be able to pay a much smaller percentage of your debt than what you originally owed. This translates to paying less interest and having more of your payments go toward the principal, saving you even more money and wrapping up your debt payments sooner.
Avoid dealing with debt collectors: Not having to deal with the stress of phone calls and letters from a debt collection agency is another benefit of seeking debt forgiveness. Those attempts to get you to pay up can snowball into lawsuits and wage garnishment.
Drawbacks of debt forgiveness
Could owe taxes on the forgiven amount: Generally, forgiven debt is considered taxable income and must be reported to the IRS by the lender. For instance, if you owed $20,000 in debt and settled for $15,000, you’d be required to pay income tax on the $5,000 of forgiven debt. While there are some exceptions, most canceled debt is taxable as long as the amount is $600 or greater.
Possibly owe more than when you began: If you don’t take the time to understand why you needed debt forgiveness and change your financial habits accordingly, you may end up right back where you started, or even be worse off. Plus, debt relief companies can charge high fees for their services, which may cancel out any benefit you gain from forgiven debt.
Negative impact to your credit score: Unfortunately, most types of debt forgiveness, including filing for bankruptcy, seeking a short sale for your home or applying for credit card forgiveness, will hurt your credit score. However, student loan forgiveness programs can be the exception, and some medical debts are less commonly reported to credit bureaus.
Could leave you vulnerable to debt settlement scams: While there are plenty of reputable companies out there, you may also encounter debt settlement scams. If you choose this route, check each company’s customer reviews on the Better Business Bureau before you sign up.
Alternatives for debt management
If you’re not a good candidate for debt forgiveness, consider the options below to help manage your financial situation.
Debt consolidation
If you’re managing multiple sources of debt with varying rates of interest, you can use a debt consolidation loan to simplify your finances. This strategy involves taking out a single loan with a lower interest rate and using it to repay all of your creditors at once. You may be able to save money on interest with a lower, more manageable monthly payment that’s easier to track.
Credit counseling
A nonprofit credit counseling agency can help you get your finances back on track. These counselors offer tips on budgeting and assistance with reviewing your credit report, and may even help you create a debt management plan. Before working with a credit counselor, be sure they’re reputable and accredited by the National Foundation for Credit Counseling (NFCC) or Financial Counseling Association of America (FCAA).
Debt settlement
If you sign up with a third-party debt settlement company, you’ll usually be instructed to stop paying your bills and save up a lump sum instead. These savings are transferred to a jointly held account while the company negotiates settlement terms with your creditors. However, the cost for this service can be up to 25% of the debt you owe, without any guarantee that your debt will actually be forgiven.
In addition, as you pay for one more expense you can’t really afford, your credit score can be damaged even further while you wait for outcomes that could take months and miss debt payments in the interim.
Consider bankruptcy
If all else fails, there’s always the last-resort option of declaring bankruptcy. Bankruptcy can offer a fresh start, but it comes with serious downsides — including a substantial credit impact for up to 10 years, possibly making you ineligible for loans down the road. While your debts may be forgiven entirely under a Chapter 7 bankruptcy, you will need to repay some of your debt under a structured payment plan if you file for a Chapter 13 bankruptcy.