What Is Debt Forgiveness?

Debt Forgiveness Explained

A man works out debt forgiveness with a laptop, a smartphone, and a pile of papers.
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You have your debt forgiven when a lender decides that you don't have to pay the amount you have remaining. While the idea of debt forgiveness sounds great in theory, different types of debt come with their own rules, and there’s almost always a catch.

Learn more about what debt forgiveness is all about, how it can be applied to different types of debt, and what your other options are if you’re struggling.

Definition and Example of Debt Forgiveness

Debt forgiveness is when a lender reduces the amount of debt a creditor owes or wipes away the debt entirely. In most forgiveness situations, debt reduction comes with major strings attached. These may include a negative hit on your credit or tax consequences on the amount forgiven.

One of the most common types of debt forgiveness is credit card debt. If, for some reason, you can't make payments on your credit card balance, the issuer can sell the debt to a collection agency. The agency begins the collection process, attempting to contact you about the debt.

Most collectors will settle the debt for an amount that gets them their money back plus a bit more to help their business generate revenues. You can negotiate with the collector for a reduced amount and have the remainder forgiven.

How Does Debt Forgiveness Work?

Debt forgiveness can be specific to the lender. In general, it is a process that involves a lender or collector and the creditor (the borrower). Both parties agree on a course of action for the debt. Whoever is trying to collect the loan forgives the remaining debt, and the creditor agrees to pay any amount they agree upon.

Rules for forgiveness vary depending on the type of debt. While government-sponsored debt-forgiveness programs pop up from time to time, they are usually temporary.

Once you have had a debt forgiven, you no longer have a responsibility to make payments. However, there might be other financial consequences that can affect you. If the amount of debt forgiven is more than $600, the collector is required to file an Internal Revenue Service (IRS) form 1099-C, unless there are special circumstances. In general, forgiven and canceled debt is considered to be income by the IRS.

The forgiven debt is considered income because you were essentially given money by the lender or creditor when the debt was forgiven. As income, you'll need to pay taxes on it. If the collector files the 1099-C, you should receive a copy of it, so it's important to look for one in the mail if you've had a debt forgiven.

Types of Debt Forgiveness

Any type of debt can be forgiven if the circumstances allow for it. There is no guarantee that it will be with some types, but here are some of the most commonly forgiven types of debt.

Student Loan Debt Forgiveness

Of all the types of debt, federal student loans have true debt-forgiveness programs. However, you must follow very specific parameters and make payments for a certain number of years. Private student loans are generally not subject to loan forgiveness laws. However, many have programs designed for someone with a student loan debt with special circumstances that might require forgiveness.

There may be sweeping student loan debt forgiveness on the horizon; however, only time will tell.

Public Service Loan Forgiveness (PSLF)

College graduates who go on to employment with nonprofit organizations or the government may be eligible for the Public Service Loan Forgiveness program (PSLF). You must first make 120 on-time payments on your loans while working for a qualified employer. Those who meet those requirements will have the remainder of their federal student loan debt forgiven.

So far, eligible borrowers have had a hard time receiving forgiveness. The Department of Education is working to remedy this situation with a program overhaul. On October 6, 2021, the Department of Education announced a limited waiver (expiring on October 31, 2022) for those in public service.

To have the loan forgiven, you must meet the qualifying employment criteria and have made payments on Perkins Loans, Federal Family Education Loans, or non-Direct Loans, regardless of your repayment plan. The waiver also applies to anyone who consolidates their loans into a Direct Loan and submits a PSLF form by October 31, 2022.

Teacher Loan Forgiveness (TLF)

For teachers who work for five consecutive years in schools or educational service agencies in low-income areas, student loan debt forgiveness of up to $17,500 may be available. The U.S. Department of Education publishes a list of eligible low-income institutions each year.

For PSLF and teacher loan forgiveness, there is no tax liability for the forgiven debt. It's also important to note that teachers can also qualify for PSLF.

There is one other type of student loan forgiveness that has to do with the type of repayment schedule borrowers choose. For those who decide to pay back their debts using income-driven options, any remaining debt will automatically be forgiven after 20 to 25 years of repayment (depending on the program). However, for this type of forgiveness, you might have to pay income tax on the forgiven amount.

Credit Card Debt Forgiveness

When you owe money on your credit cards, there are no actual forgiveness programs that will allow you to have your balance wiped out. However, borrowers facing hardships have some options at their disposal that could help reduce or even eliminate their balances, but they have a big impact on long-term credit health.

These include debt settlement (where a third party negotiates down the amount owed) and bankruptcy (in which you can have some or all of the debt discharged).

Mortgage Debt Forgiveness

Mortgage lenders will work with borrowers in tough financial situations to help reduce their monthly bills or overall debt burdens. Some people may be able to get debt relief through modification programs (which can increase the loan term but decrease the payments), foreclosure prevention programs, and short sales.

With a loan modification, the lender agrees to reduce the loan’s principal, effectively forgiving part of the debt. With a short sale, the owner sells the home for less than the loan's value, and the lender agrees to forgive the difference rather than seek repayment of the amount still owed.

A law passed in the early days of the 2008 financial crisis changed that, and forgiven mortgage debt, up to certain amounts, was excluded from taxation. Since passage, the Mortgage Forgiveness Debt Relief Act of 2007 has been extended (and modified) several times. Currently, and through 2025, up to $750,000 of mortgage debt forgiven through a loan principal reduction or a short sale is not taxable.

Alternatives to Debt Forgiveness

Unlike the student loan forgiveness programs mentioned above, most scenarios that allow borrowers to reduce their debt only emerge once the borrower has fallen far behind on payments. If you're struggling with debt, here are some of the options that may be available to you.

DIY Negotiation

It’s always smart to work with your creditors and lenders directly if you are on the verge of financial hardship. Don’t wait until you’re missing payments. Instead, reach out and be upfront—many lenders have programs designed specifically to help borrowers get through rough patches.

You might even be able to reduce your balance by agreeing to pay a lump sum. This tactic can be especially effective in the case of medical debt. Other times, you could try working out a payment plan, which usually involves breaking up a large balance over a period of time. Or you might ask about lowering your minimum payments temporarily until you’re back on your feet.

Credit Counseling

Before resorting to debt strategies that could harm your credit or that you don’t fully understand, you should start by researching your options. The best place to start is with a nonprofit credit counseling organization. They will first help you assess your situation, then go over the pros and cons of your options. If you choose to work with a credit counselor, they can also help you negotiate a payment plan for your unsecured debt.

Credit counseling can also be used proactively to help you become familiar with ways to avoid getting into a situation where you might need to negotiate for debt forgiveness.

Debt Management Plans

If you have multiple unsecured debt balances, you may decide to enlist the help of a credit counseling agency that can work out a formal debt management plan (DMP) for you with your creditors. You then pay the credit counseling agency a set amount each month, and it makes the payments to your creditors on your behalf.

Debt Settlement

Some consumers seek the help of a third-party debt settlement company, which may ask creditors for partial debt forgiveness on your behalf, among other tactics. Just be mindful that debt settlement firms charge fees, their strategies can hurt your credit, and there are some shady players in this space. Be sure to do your research to find a reputable debt relief company.

The debt settlement process can do major damage to your credit score. You will also have to report the amount of debt forgiven as taxable income.

Bankruptcy

Some consumers can discharge a portion or all of their debt through a formal bankruptcy process. How the debt is handled will depend on if you file for Chapter 7 or Chapter 13 bankruptcy, the latter of which requires you to complete a repayment plan over a set amount of time before the remaining debt is cleared.

Key Takeaways

  • Debt forgiveness is when a lender or creditor who has purchased your debt forgives the amount you have remaining.
  • Forgiven debt, in many cases, is treated as income by the Internal Revenue Service and taxed.
  • There are different types of debt forgiveness, and each is treated differently according to the type of debt.
  • There are a few alternatives that can help you manage your financial situation and alleviate some of the damage to your credit that forgiveness can cause.