Why debt forgiveness is not as forgiving as it looks

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Having debt can feel overwhelming. If at some point that feeling becomes a reality and it seems like you won’t be able to continue to make your debt payments, then you may want to consider pursuing debt forgiveness options.

If someone borrows money under a legal agreement to repay the money they borrowed (whether it be a fixed or determinable amount), then they have debt. If a debt is forgiven (aka debt forgiveness), then the debt is considered canceled and the amount that was still owed is no longer required to be paid.

What is debt forgiveness?

Debt forgiveness happens when a lender forgives either all or some of a borrower’s outstanding balance on their loan or credit account. For a creditor to erase a portion of the debt or the entirety of debt owed, typically the borrower must qualify for a special program.

While this sounds like an ideal debt solution, debt forgiveness is not all it’s cracked up to be. Let’s take a closer look at how debt forgiveness works across various debt types and the pros and cons of this process.

How does debt forgiveness work?

How debt forgiveness works can vary depending on what type of debt you’re looking to get forgiven. Here are a few of the more common forms of debt that may qualify for debt forgiveness, as well as some debts that typically don’t.

Student loan debt

Student loan debt forgiveness programs are one of the more commonly discussed forgiveness options. Essentially, once federal student loan debt is forgiven (private student loan debt forgiveness programs can be difficult to find), the borrower won’t be required to make student loan payments in the future. Borrowers may qualify for these programs if they meet special circumstances, such as if they experience a total and permanent disability or the school where they received their loans closes.

Generally, when someone references student debt forgiveness programs, they are referring to a conglomerate of programs for students designed to lead to the forgiveness of part or all of their student loan debt. Typically, each program has its own unique requirements and approval standards and there are programs designed to fill specific niches. For example, some professions like nursing and teaching have more options for student loan forgiveness.

When it comes to student loan forgiveness, there are a few benefits and downsides worth looking out for.

Pros

  • There are a variety of programs that make student loan forgiveness widely available.
  • Certain professions (such as nursing or teaching) have a leg up and may qualify for a specialized program.
  • Even if you can’t get all of your debt wiped away, you can likely get some of it forgiven.
  • You can save money on student loan payments in the long run.
  • You can get out of debt faster.

Cons

  • In some cases, student loan forgiveness is a taxable event. Income-driven plans are an example of when you may find a tax bill on your hands post-forgiveness. This is because, under some programs, forgiven loan amounts are viewed as taxable income.
  • There are plenty of debt relief scams targeting people with student loan debt, which can make it hard to know if you’re actually going to get debt relief.
  • Private student loans generally aren’t eligible for forgiveness as most forgiveness programs are backed by the federal government and intended for federal student loans.
  • Forgiveness generally doesn’t happen overnight, and each program varies in length. In some cases, you may need to wait over a decade to qualify for forgiveness. If the time frame is too long, it may be more beneficial to just pay off your debt as quickly as possible so you don’t have to worry about monthly payments any longer.
  • If you have already defaulted on your federal student loans, you not only lose all federal protections and benefits, but you won’t qualify for forgiveness.

Medical debt

Medical bills can mount quickly and many people struggle to pay for them. Because so many people face medical debt-related challenges, there are processes in place for getting help with this type of debt in the form of medical bill debt forgiveness programs. You can call the hospital where you incurred your debt and ask to learn more about qualifying for the hospital’s “financial assistance policy.” Some hospitals may call this “charity care” and these programs typically look at income when deciding who qualifies. In some cases, the hospital may lower your bill significantly or forgive it completely. Nonprofit hospitals are actually legally required to have assistance policies.

Pros

  • Even if you don’t qualify for complete forgiveness, financial assistance may be available.
  • There is no set limit for how much you need to earn and often, medical debt forgiveness is awarded on a sliding scale. This means if your income doesn’t qualify for full forgiveness, you can still qualify for partial forgiveness.
  • If you don’t qualify for forgiveness at all, there are other options for reducing medical debt. For example, if you offer to pay a smaller amount than what is due but do so in one lump sum, you may be able to get your bill reduced.

Cons

  • It can take a bit of work to get medical debt forgiven and there’s no guarantee that you’ll get the desired end result.
  • You may need to provide the medical institution with documentation like tax returns and pay stubs in order to prove the need.

Tax debt

If you don’t have enough money to pay your taxes, you may find you have tax debt and can qualify for an IRS debt forgiveness program. The IRS has a few options to help make repaying that debt more manageable. One of these options, known as “offer in compromise” (OIC), occurs when you owe more than you can afford to pay.

To qualify for OIC, you’ll need to prove that paying that bill will be detrimental to your finances and if approved, you may be allowed to settle your debt for less than you owe. This is usually only an option if you’ve exhausted all other payment choices. The IRS takes your income, expenses, asset equity and ability to pay into consideration. If the IRS believes you can actually pay off your debt, whether in full or in installments, then you won’t qualify for an OIC.

Pros

  • An OIC allows you to settle your debt for less than you owe, saving you stress and money.
  • If you don’t qualify for OIC, the IRS offers installment agreements that allow you to make small, manageable payments until your debt is paid off.

Cons

  • Tax debt relief scams abound. Anyone who guarantees reduced or eliminated IRS debt, especially without actually reviewing your financial situation, is likely running a scam. It’s always best to work directly with the IRS.

Mortgage debt

Unfortunately, mortgage debt forgiveness is pretty hard to come across these days. This is partly because the housing crisis led to lenders having to forgive too much housing debt, and they don’t want to end up in a similar situation again. That being said, mortgage forgiveness can happen. It’s just very unlikely.

Because mortgage loans are secured with collateral in the form of your home, it’s more likely that you will be able to receive a mortgage modification from the lender. A mortgage modification occurs when your lender agrees to alter your original loan so that it is more manageable under your current financial situation.

Pros

  • While full forgiveness might not be an option, mortgage modification can make your monthly payments much more manageable.
  • A mortgage modification can even lower the amount of principal that you owe.
  • Plenty of conventional lenders offer modification and this can be available for FHA-issued mortgages as well.

Cons

  • Complete mortgage forgiveness is rare and hard to qualify for.

Credit card debt

Credit cards are another example of a type of debt that generally doesn’t have forgiveness options. Credit card debt forgiveness is unlikely as credit card issuers tend to expect you to repay the money you borrow, and if you don’t repay that money, your debt can end up in collections.

When it comes to credit cards, debt settlement is a more likely option and is the closest alternative to forgiveness. Basically, credit card debt settlement is a process in which you make an agreement with your lender to pay less than what you currently owe them. It can be wise to try to tackle these negotiations on your own and avoid debt settlement firms. When working with a debt settlement firm, you typically end up owing your payments to the firm instead of the lender.

Pros

  • Debt settlement can lower your monthly payments and make debt easier to pay down.
  • You may be able to agree to pay them a lump sum that is less than what you owe in exchange for stopping payments.

Cons

  • Debt settlement companies are often predatory and your credit score can end up damaged as a result of their actions. Not to mention, they can charge hefty fees.
  • Working with a lender directly to settle your debt is a better alternative, but by the time a lender is likely to consider this option, the odds are your payments will be overdue and your credit score will already have taken a hit.

Benefits of debt forgiveness

While the main benefit of debt forgiveness is pretty straightforward (you have less debt to pay), there are a few other benefits worth considering.

Your credit score isn’t impacted

Not being able to pay off your debt can lead to credit score damage due to late or missed payments. When your debt is forgiven, your credit score is generally not affected. Having less debt can also improve your credit utilization which helps boost your credit score.

Lenders won’t come after you

Once your debt is forgiven, you aren’t responsible for the amount forgiven, whether it was for the full amount of debt or just part of it. This means that you won’t have to worry about a lender coming after you to collect the debt down the line.

Downsides of debt forgiveness

Debt forgiveness isn’t a perfect process, and the major downside associated with debt forgiveness may outweigh the perks. It will be up to you to decide if it’s worth it or not.

Taxes

Debt forgiveness does not magically wipe away all financial responsibility. Once a debt is forgiven, the forgiven amount is treated as taxable income. The IRS takes most forms of forgiven debt under consideration.

If your forgiven debt amounts to more than $600 and is determined to be taxable, then your lender is required to issue you a 1099-C form that includes the canceled amount you should report. If your forgiven debt amounts to less than $600, then you may not receive a 1099-C. Even without this form, you’ll have to report it on your next tax return.

If you have a lot of forgiven debt, you may find you have a very large tax bill on your hands.

Shady debt settlement agencies

There are a lot of shady agencies ready to prey on people in crisis. Some debt settlement agencies charge money to handle tasks you could have done on your own (such as contacting a credit card issuer’s hardship department); others are outright scams that take your money without doing any work toward reducing your debt. Do your due diligence before signing up with any debt settlement, credit card consolidation, or credit repair program—consult the Better Business Bureau, look for user reviews, and avoid any program that charges fees upfront.

Alternatives for managing debt

If you decide that debt forgiveness is not the best path for you or isn’t an option that you qualify for, you may want to begin considering alternative ways to manage your debt.

Debt consolidation

Debt consolidation occurs when someone merges multiple sources of debt into a single debt. The upside of doing this is that you can manage just one payment instead of paying multiple lenders each month. Ideally, when you consolidate your debt, you’ll be able to get your hands on a lower interest rate that will save you money and make the debt easier and faster to pay off.

With debt consolidation, you’ll still need to pay off your debts, but in some cases, this strategy can make paying off debt simpler and less expensive. You can consolidate several types of debt from credit cards and medical debts to personal, student and auto loans.

Balance transfer credit card

If you are on a stable path to paying off your credit card debt, a balance transfer credit card can be a great strategy for paying down debt. A balance transfer card allows you to transfer multiple sources of credit card debt onto one credit card. Ideally, you’ll take multiple sources of high-interest credit card debt and transfer them to a single credit card with a lower interest rate. Some balance transfer credit cards have 0 percent intro APR offers that can make paying down debt even less expensive.

Debt settlement

If you’re struggling to pay off your debt, you may want to call your creditors and negotiate a settlement of your debts. Typically, a debt settlement allows you to pay off much less than you owe. It’s worth noting that the Federal Trade Commission has raised some concerns about debt settlement companies, as they may instruct you to stop making payments on your debt during the negotiation process, which can hurt your credit score.

Debt management plan

A debt management plan is a program that provides participants with a structured repayment plan that will help them pay off their debts under the direction and guidance of a credit counselor. Generally, the debts under a plan like this qualify for waived fees and reduced interest rates. This means that a debt management plan may have similar benefits as consolidation but can be easier to qualify for if you have a lower credit score.

The bottom line

At the end of the day, debt forgiveness can provide some major financial relief for those struggling with debt, but it can also lead to pricey tax bills. Not all debts qualify for forgiveness, but forgiveness programs can offer some much-needed assistance if they do. You’ll want to carefully consider all of your debt management options to make sure debt forgiveness is the right option for your financial situation.