Since childhood, we are taught that it’s always better to forgive that to hold resentment. Does it apply to the massive amount of debt we accumulated? Debt forgiveness is a real thing, but it comes with strings attached. Scam artists become more skillful in targeting struggling debt owners and promising to wipe all their debt in no time-with no consequences!
To be fair having your debt wiped out sounds so appealing. But it’s more complicated than that. Before resorting to debt forgiveness, it’s important to understand what it represents and how it can affect your finances long term.
What is Debt Forgiveness?
Debt forgiveness is when a creditor or lender forgives an amount of money you owe them. It’s also when interest rates on a remaining debt get reduced to a very low percent or zero. It can be credit card debt, student loans, mortgage, or even tax debt.
When something sounds too good to be true it usually is – so what’s the catch? It’s rarely fully forgiven, and in most cases, you still need some money to qualify for debt forgiveness.
Get informed of all the options and pay attention to hidden details. Debt forgiveness is created for people struggling to make ends meet; it’s not there for you to cheat the system when you’re doing well.
Different Types of Debt Forgiveness
Student Loan Forgiveness
The amount of student debt in 2020 is higher than ever before, reaching about 1.5 trillion dollars. There are a few political promises of debt forgiveness plans in the future, but let’s take a look at what is available today. Programs for repaying or canceling all your student debt have been around for a while. The lack of popularity is because not many qualify for them.
The circumstances for a student loan to be fully discharged are permanent disability of the borrower, identity fraud, school closure during the time of the study, or death.
Dropping out or not being able to find a job right after graduation doesn’t count in these circumstances. For all these and many other cases, there are public service loan forgiveness and repayment plans with loan forgiveness.
Public Service Loan Forgiveness
Available for people working public service jobs for the government or a non-profit organization. Who is eligible? Social workers, teachers, medical personnel, people working for the military, firefighters, and volunteers.
What does it represent? After paying the minimum amount for 10 years or 120 monthly payments, your remaining debt is forgiven. During these 10 years, you have to stay with the eligible employer mentioned above.
If you quit your job with the eligible employer before the 10-year mark the debt is not forgiven.
These are low paying jobs and you have to decide if it’s worth spending 10 years working a low paying job to have your debt forgiven, or go into the private sector where you can earn more and pay your debt quicker without forgiveness.
Repayment Plans with Loan Forgiveness
Created for people struggling to pay the big monthly payments. Debt can be reduced to a minimum monthly payment and forgiven after 20 to 25 years of repayment.
Who is eligible? Everyone, you don’t have to work with a specific employer.
An income-based repayment plan comes with debt forgiveness after 25 consecutive years of payments. The maximum monthly payment is 15% of your discretionary income.
Income-Contingent repayment plan comes with annually recalculated payment. The payment size depends on family size, gross income, and remaining debt. This plan also offers debt forgiveness after 25 years.
Pay As You Earn is a plan with monthly payments of 10% of your discretionary income and debt forgiveness after 20 years.
The repayment plans with loan forgiveness stretch out your loan for a longer period of time which makes your interest rates go up and your loan increase. Your payments change annually depending on your earnings so the more you earn the more you pay.
All the plans mentioned above are for federal loans only. If you’re with a private lender contact them to get an offer.
Credit Card Debt Forgiveness
When you’re long overdue on your credit card payments debt forgiveness sure sounds tempting.
But is credit card debt forgiveness real? Your options to get rid of at least a portion of your credit card debt include debt settlement, debt management plan, or bankruptcy.
Debt settlement is done when the creditor is faced with a customer who pays next to nothing on their debt. Getting a creditor to negotiate a settlement with you is hard and the procedure can take months or even years. It can’t be done if you’re up to date on your other bills.
If using a settlement agency you pay monthly payments towards them that go into a savings account. When they feel there is enough money to negotiate with the creditor they will try to settle your debt for you.
Beware of debt settlement agencies promising to” wipe off all your debt for pennies”.
What an agency can do legally you can do it yourself at no charge.
If you can, try to negotiate with the original creditor and get any settlement you reach in writing.
Even if you negotiate yourself your creditor might sue you or sell your debt to a third-party collection agency. In this case, you’d still be responsible for paying a portion of your debt, have to deal with judgments and wage garnishments.
Forgiven credit card debt shows on your credit report up to 7 years and damages your credit score.
Any forgiven debt above 600$ is counted as taxable income by the IRS.
Debt Management Plan (DMP)
A debt management plan is systematic approach credit counselors use to get you rid of debt. There are non-profit credit counselors that have established relations with all the major companies and will negotiate for you.
As a bonus, you get free debt counseling to avoid future mistakes. While it sounds nothing like debt forgiveness a DMP can lower your monthly payments and interest rate, which saves you tons of money!
The DMP won’t drastically affect your credit score. What will is the obligatory closing of your credit accounts.
You still need to make on-time monthly payments and follow the plan to become debt-free.
Mortgage Debt Forgiveness
A mortgage you can no longer afford to pay is big trouble. Mortgage debt forgiveness rarely happens because the mortgage is a secured loan which means the lender has collateral –your house. The lender can seize it and sell it to make up for their losses.
The mortgage debt forgiveness is applied to the remaining unpaid balance, but only after going through the painful process of losing your house.
Some modifications can be done to your mortgage, like refinancing as a way to keep your property and make your payments more affordable. A lender will on occasion shave of some portion of your debt or reduce the principal balance.
If you get a portion of your mortgage forgiven it is counted as taxable income. Refinancing your mortgage for lower payments means extending the time period which will crack up the interest rates.
Tax Debt Forgiveness
Not everyone gets money back when Tax Day comes. For some, it’s the day they find out they owe money to the IRS.
The good news is the IRS offers a program to help taxpayers sort out their debt without paying the full amount. The program is called an offer in compromise.
To see if you’re eligible the IRS will look into your assets, income, and expenses. If they decide that paying your taxes in full will put you in a hard position they will approve an OIC on how much they can collect from you in a reasonable time.
They offer a lump sum plan where you pay 20% in advance and the rest within 5 months; or a monthly payment plan for 6 to 24 months. Any remaining debt is forgiven.
To get tax debt forgiven you have to be nearly insolvent. You can get tax debt forgiven when the IRS has decided that they really can’t collect more payments from you in the foreseeable future.
Tackling debt is the first step towards financial freedom. While on-time payments are the best option sometimes life happens and you can end up buried in debt. This is when debt forgiveness seems like a spark of hope, but proceed with caution.
Any forgiven debt damages your credit score tremendously and it ruins the opportunity for you to get a good deal with other lenders in the future. Some forgiven debt stays on your credit report for years.
Except for tax debt, any other forgiven debt is looked like as an income and you end up with a higher tax bill the following year.
It’s good to know that if you are struggling there is a possible solution, but resort to debt forgiveness as your last option before bankruptcy.