Credit and Debt Blog

When examining debt relief options, clearly forgiveness of debt can be an appealing idea. Imagine getting all or a portion of your debt forgiven rather than having to deal with debt collectors and legal action! If it sounds too good to be true, understand that there are many consequences of debt forgiveness that could leave you in worse shape.

Debt forgiveness refers to the act of a creditor excusing a debtor from repayment of a debt. Debtors often are willing to forgive a portion of a debt as an alternative to nonpayment.

Debt forgiveness is more than just ignoring a debt. Many accounts are never collected on or pursued in court for a number of reasons. Debt forgiveness goes a step further.

It refers to a cancellation of debt so that it is no longer collectible. The account is considered closed.

How Can My Debt be Forgiven?

When dealing with the original creditor, you may be able to proactively negotiate cancellation of certain fees. This is the preferred method of gaining forgiveness for some of your debt without any repercussions. If you have been a good customer but made a one-time mistake, ask for forgiveness from your lender. Banks, credit unions and credit card issuers all fall into this situation.

If you are falling 4-6 months behind, you may be able to negotiate a settlement directly with your lender. Please note that this does not include hiring a debt settlement company, which will be discussed a bit later!

Most lenders are required by law to report a balance as uncollectible once it is 180 days (6 months) delinquent. That means they must record it as a bad debt and write it off as a loss. As a way of reducing this bad debt expense, the account is often sold to a collection agency for 10-25% of the balance, depending on the type of account. If you are able to pay the lender more than that amount, then they might be willing to accept a settlement.

A settlement is a lump sum payment that is accepted by the lender as a final payment on the account. The remainder of the debt that was unpaid is forgiven.

Can Debt Settlement Companies Help?

Debt settlement companies rarely help. Those few clients that do succeed in settling their debts by utilizing a debt settlement company likely could have successfully settled their own debts and saved the several thousands of dollars that they paid in fees to the debt settlement company.

The vast majority of clients that hire a debt settlement company fail to settle, and many are out the money that they paid to the company. Lenders and debt collectors deplore debt settlement companies, since they rarely collect on accounts that are being “managed” by these companies.

What is the Downside of Debt Forgiveness?

There are actually several downsides to having a debt forgiven. The one upside is that you may pay somewhat less than what you owe. Other than that, it doesn’t look very good.

• A lump sum payment is required if you are going to settle a debt. If you had all of that cash on hand, wouldn’t you have been paying your bills all along?
• Your credit will suffer from reports that you settled an account for less than the full amount. This settlement payment will be reflected as a negative record on your credit report for many years to come. In other words, it will continue to haunt you as you try to make other purchases on credit. Even employers or landlords might fret about giving you a chance based on your damaged credit.
• You can owe more tax based on debt forgiveness. The Internal Revenue Service considers debt forgiveness as a gift from a lender. It is viewed as income, and you are expected to pay taxes on that forgiven debt. Any forgiven debt of $600 or more is automatically reported to the IRS and you will receive Form 1099-C as documentation of your untaxed “income.”

As you can see, there are many consequences of debt forgiveness that may outweigh the benefit of having part of your debt cancelled. Depending on your situation, you might be far better off investigating some of the other options available, including credit counseling and bankruptcy.