Understanding Debt Forgiveness and How It Works

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Debt is a slippery slope. What started as a small amount can quickly snowball due to interest and fees. This isn’t including any additional loans or credit taken, which can make debt totals climb even faster. In fact, the average debt of any household with debt, was $144,100 in 2018.

When you’re fighting to pay off debt, it can feel like progress is slow, or not happening at all. This can make the idea of debt forgiveness even more appealing. Having your debt forgiven without having to pay all of it off? Why wouldn’t you want that? But, who exactly makes a good candidate for debt forgiveness?

What is Debt Forgiveness and Why Would You Need It? 

Whether you’re talking about credit card debt, student debt, or even personal loans, the idea of debt forgiveness is that a creditor will forgive all or some of your debt. There are generally strings attached, but if debts are completely overwhelming you then forgiveness can be an option.

So, who exactly makes an ideal candidate for debt forgiveness? In short, anyone that’s making little or no progress on paying off their debts could be a candidate. There are of course numerous caveats that go with that.

6 Types of Debt Forgiveness and How They Work

Debt forgiveness comes in many forms, many of which are more suitable for one type of debt over another. While “forgiveness” is in the name, in many cases debt forgiveness actually translates to a payment plan where the debt is reduced as long as the person makes regular payments.

Below are some of the most common debt forgiveness and consolidation plans. Think about your own situation carefully to get an idea of which debt plans might be best for you.

Student Loan Forgiveness

Student loan forgiveness is a type of debt forgiveness applicable only to student loans. To receive this, students must apply for forgiveness through the U.S. Department of Education Federal Student Aid office. If approved, some or all of your student loans may be forgiven.

While anyone can apply, it’s worth noting that 99.5% of applicants in 2018 were denied any aid.

Debt Settlement

A debt settlement is an agreement between you and the lender. When a settlement is reached, you agree to pay back a portion of the debt at a set rate over a period of time. Most debt settlements are reached using a third party company, which will process the payments as opposed to you paying the credit card company directly.

There are some potential pitfalls with debt settlement, as the lender can in some cases decide to sue you. This can result in a lien on your property, your pay being docked, or even seizure of your assets. It’s also worth pointing out that often times a debt settlement plan can result in your credit scores taking a serious hit if you miss any payments. Make sure you speak with a financial professional before moving forward with this, as you will likely need to pay taxes on the cancelled debt.


Bankruptcy is a drastic measure that can wipe away existing debt or result in a debt repayment plan. If you file a Chapter 7 bankruptcy, some of your property is sold off and used to clear the debt in your name. This results in a near or total liquidation of your debt, but can also stay on your credit report for up to 10 years and drastically hurt your overall credit.

A Chapter 13 bankruptcy allows your debt to be reduced and a payment plan to be formulated. This plan is typically three to five years and gives you the time you need to pay off your debt. Unlike a Chapter 7 bankruptcy, a Chapter 13 won’t necessarily hurt your credit in the same way. While it can stay on your report for up to 10 years, it can in some cases be less damaging than the missed payments and climbing credit debt that comes with not being able to pay off your total debts.

If you feel your debt is absolutely out of hand, speak with a financial professional before deciding to move forward with any form of bankruptcy, as it’s a decision that will stay with you for years.

Income-Driven Repayment

If you have student loan debt, income-driven repayment (IDR) could be an option to consider. With an IDR your loan payments are adjusted to a level that’s more manageable depending on what you make. In some extreme cases the payment can be as low as $0 per month.

To apply for an IDR, you need to go through the U.S. Department of Education Federal Student Aid. There are four types of IDR, each suited for different situations. Contacted the Federal Student Aid department will be the best way to determine which type of IDR is right for you.

Debt Consolidation

Debt consolidation is the act of combining your debts into one lump sum. This amount is then paid off using a private loan, clearing your aggressive credit and other debts. The loan is then paid off over the predetermined period at a set rate each month.

While you still end up paying off the total debt amount with consolidation, you are left with an often much more manageable payment than with a credit card. Private loans can have much lower interest rates and much longer terms, meaning your monthly payment is typically lower than what’s required to catch up on a credit card or other type of debt.

Debt Management Plan (DMP)

A debt management plan (DMP) is a type of debt consolidation done through a DMP company. A DMP company will work with you and your creditor to lower what you owe. This can be accomplished by reducing the total owed, the interest rates, and even the fees tied to the debt.

In some cases the debt is consolidated onto a single credit card, making it easier to track and pay. In other cases, the debt itself is lowered and cleared using other funds, much like a debt consolidation plan. Generally, it can take anywhere from three to five years to clear debt using this method.

Debt Forgiveness Application Hurdles

Debt forgiveness and the related programs are all huge decisions, each with different implications and possible risks. Before making any major financial decision you should speak with a financial advisor, as they’ll be able to help you make an informed choice.

The following are some things to consider before you speak with an advisor, as they’ll help you be mindful of what to look for if you move forward with the process, and help you think of questions to ask your advisor.

Know the Tax Consequences

As the old saying goes, “there’s no such thing as a free lunch.” With debt forgiveness there can be large tax consequences. One major side effect of receiving debt forgiveness is that any forgiven debt must be claimed via a 1099-C and counted as income. This can have even larger implications if it pushes you into the next tax bracket, which can result in a large jump in how much you pay.

Read the Fine Print

Anytime you’re considering any major financial decision, especially one tied to your debt, read the fine print of the agreement and ask questions. It’s not that people will intentionally mislead you in every case, but debt forgiveness plans can be so nuanced that details can be lost during the exchange.

In short: read everything and make sure you’re getting an accurate picture of what it is you’re agreeing to, before you agree to it.

Be Realistic

It never hurts to be realistic. If you’re interested in student loan forgiveness, know that the odds aren’t in your favor. If you’re looking into any kind of major debt repayment plan, keep in mind that you’re still looking at a journey that will likely take years to complete. Clearing your debt is a must, but it will also take time.

Speak to an Expert

Always speak with an expert before you agree to anything or give anyone your information. There are countless sites and organizations looking to scam people. Outside of this, even the legitimate agreements carry major implications. An expert will help ensure you don’t walk into any pitfalls or agree to anything fraudulent.

Living Debt Free

Becoming debt free won’t happen overnight, but it’s absolutely worth the effort to get there. It’s never too late to start working on your debt, no matter how small or large it is.

Take in a deep breath, clear your head, and speak with an expert about your options. No matter your situation, there’s almost always something that can be done to help you get out of it. Remember: the longer you wait, the worse it will get. Take action now and own your financial future.

Save more, spend smarter, and make your money go further