First of all, it’s important to know that true credit card debt forgiveness is largely a myth. Credit card debt forgiveness, unlike student loan forgiveness or mortgage deficit forgiveness, comes with a lot of conditions—anything but a get out of jail free card.
However, it is not uncommon to find some level of debt reduction through channels such as credit counseling, debt settlement, and even bankruptcy.
Let’s take a look at what each of them entails and what it will do for your credit card debt and your credit score.
What is debt forgiveness?
Debt forgiveness occurs when a lender or creditor forgives all or part of the debt that someone owes on an outstanding loan or credit account. Legitimate debt relief programs are becoming less common these days, but consumers still have a few options.
Types of debt forgiveness
Let’s look at two popular debt forgiveness models to understand how it works:
Bankruptcy
Bankruptcy requires the toughest price on your credit. This should be the last of your options when it comes to exorbitant debt, including credit card debt.
Generally, the higher your credit score approaches bankruptcy, the more points you lose. So if you’ve been at the 760 level before, don’t be surprised if you face a 200 pip drop.
It is true that if you are eligible to file for Chapter 7 bankruptcy, any credit card debt you owe will be effectively paid off and you can start over, the “silver lining” of filing for bankruptcy. It’s important to note that not all of your debts can be written off, even if you’re applying for Chapter 7—taxes, alimony, and student loans are among the debts that won’t be written off.
Filing a Chapter 7 application requires a means check to determine if you really cannot afford to pay at least some of your bills. If you can’t pass this means test, you’re probably looking at chapter 13 enrollment.
If you file under chapter 13, you will have to make payments on your debt, and while those payments are likely to be reduced, they will eat up a significant portion of your income. Also note that debts paid off in bankruptcy – be it chapter 7 or chapter 13 – are not subject to income tax as they are liquidated, not forgiven, so at least one less problem.
While bankruptcy exists in this country for very good reasons, it will severely damage your credit history by staying on your credit report for up to 10 years. Think carefully before going into bankruptcy to get rid of credit card debt.
student loan debt
Those who have federal student loan debt may be eligible for the Student Loan Forgiveness Program. If someone’s federal student loans are forgiven, canceled, or released, that means they no longer have to pay off the remaining amount. Student loan forgiveness can happen if someone experiences a complete and permanent disability, or if the school they borrowed to attend closes, among other scenarios.
medical debt
Medical bills can get very expensive very quickly. For this reason, some hospitals have programs to write off medical bills (non-profit hospitals are required by law to have such programs). To find out if you qualify, you can call the hospital where you have a debt and ask how you qualify for the hospital’s “financial assistance policy” or “charitable assistance.” Generally, your income is taken into account when determining if you qualify. Even if the debt is not completely written off, you can lower your bill significantly.
tax debt
If someone cannot afford to pay taxes and ends up in tax debt, they may qualify for the IRS debt relief program. The IRS offers several different ways to make tax debt management more feasible.
Advantages and disadvantages of debt forgiveness
There are several advantages and disadvantages associated with debt forgiveness that are worth keeping in mind before going down this path:
Advantages
- You will have less or no debt to pay.
- Your credit score may remain intact (unless you file for bankruptcy).
- Creditors will not send your debt for collection.
Flaws
- Debt forgiven is considered taxable income and can result in a large tax bill.
- Sometimes only part of the debt is forgiven.
- Underground debt settlement agencies prey on people who are deep in debt.
Alternative Ways to Manage Debt
If debt forgiveness doesn’t seem like the right fit for you, there are a few other options that can make it easier to pay off your debt:
Debt settlement
Debt settlement isn’t exactly debt forgiveness, but it can be more gentle on your credit score and can make it easier to pay off large amounts of debt. The idea of paying only a fraction of what you owe is certainly attractive if you’re struggling.
You also have to be very careful about paying off your debt, although the time period over which this will affect your credit report is seven years, not 10. So this is a small plus, but the damage to your score will be significant. If the lender decides to repay less than you owe, the forgiven balance will be written off and your credit report will be marked “debt paid.”
If you’ve managed to get some of your debt forgiven, keep in mind that any forgiveness comes from your creditor, not the IRS, which will treat any forgiven amounts over $600 as taxable income.
Debt management plan
Nonprofit credit counseling is often the best choice when it comes to dealing with huge credit card debt. These are the good guys who have established relationships with most of the big creditors and have already done the work of closing deals that will get you out of debt in five years or less. Commonly known as Debt Management Plans (DMPs), this is a systematic credit counseling approach to getting you out of credit card debt. And this approach also offers an invaluable credit education that will help you avoid future problems (without the nasty side effects of bankruptcy).
bottom line
Debt can be intimidating, but there are ways to move forward that can make debt more manageable. Even if you can’t fully forgive your debt, talk to your creditor about your options. They may pay off your debt at a lower rate or offer you a new repayment plan that is better suited to you.
Editorial disclaimer
The editorial content on this page is based solely on the objective judgment of our contributors and is not based on advertising. It was not provided or ordered by credit card issuers. However, we may receive compensation when you click on links to our partners’ products.
