Debt forgiveness is real — but it may come with consequences

Thoughtful woman in the park thinking about debt forgiveness and wondering if she can get itImage: Thoughtful woman in the park thinking about debt forgiveness and wondering if she can get it

In a Nutshell

If you’re struggling to cover debt payments or feel like you’ll never be able to pay everything off, there may be options that forgive some or all of what you owe, as well as other ways to handle unmanageable debt. Just be sure you understand the consequences.
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Trying to pay down major debt can feel like slowly chipping away at an iceberg.

This can be especially true when dealing with high interest charges. While repaying what you’ve borrowed (and then some) can be a tough financial reality, it may not be your only option — or even your best option.

Enter debt forgiveness.

Debt forgiveness is simple in theory: a lender forgives some or all of the debt you still owe on a loan. But this undeniably appealing concept almost always comes with strings attached.

Before seriously considering debt forgiveness as an option, keep your eyes open and avoid the pitfalls of wishful thinking. Knowing the catches of a debt forgiveness plan — and sniffing out scam artists ahead of time — can save you a lot of grief further down the line.

All of this isn’t necessarily meant to dissuade you from pursuing debt forgiveness. Depending on your circumstances and the type of debt you owe, certain debt forgiveness options may grant you access to …

  • Debt forgiveness for less than the full balance
  • In rarer cases, full forgiveness of some debts

Let’s take a look at some debt forgiveness options that may be available to you, and some other ways that could potentially make your debt more manageable. It’s important to understand your options — and any possible consequences — so that you can make an informed choice.

Student loan debt

Your options for student loan forgiveness may depend on factors such as your income, the kind of work you do and the amount of money you owe.

Programs that forgive or cancel student loan debt can be hard to come by. Several of the more notable programs are only available to those who work in certain professions, such as education and public service, or for very specific and rare situations, such as bankruptcy.

You don’t necessarily need to teach or work in public service to get some help paying off your federal student loans. Let’s look at a few other options that may apply to you.


Student loan forgiveness for teachers and public servants

Some teachers with federal student loan debt can take advantage of federal programs, such as the Teacher Loan Forgiveness Program, to reduce the total amount of money they owe on certain loans.

Other public servants may qualify for the Public Service Loan Forgiveness Program, which forgives the remaining balance on some federal loans after certain criteria have been met.

Debt consolidation

If you have federal student loan debt, you may be eligible for a direct consolidation loan, which would allow you to combine multiple federal education loans into one, giving you a simpler monthly payment with the option to switch to a lower payment with a longer term, and from a variable rate to a fixed interest rate. Just keep in mind that “consolidation” does not mean “forgiveness,” and you may end up paying even more in interest if you opt to increase the loan’s term.

Other repayment plans might make more sense for you. Learn more about what you qualify for by checking with the U.S. Department of Education.

Income-based plans

The U.S. Department of Education offers special repayment options based on your income and family size, and how much they determine you can afford to pay. If your income is low enough or your family large enough, this could mean having your monthly payment reduced to as little as $0 each month.


How is my monthly payment calculated under an income-based repayment plan?

Typically, your payment is a percentage of your discretionary income, but the exact amount may differ depending on the plan.

If you’re struggling to cover your monthly bills, asking about income-based repayment plans may be a first step toward better managing your student loan debt.

These plans can help make monthly bills more manageable, but borrowers should consider the bigger picture. The lower payments and longer repayment periods offered will likely mean that you’ll end up paying much more in interest over the life of the debt.

And under all four income-based repayment plans currently available for federal student loans, any remaining loan balance may be forgiven if your loans aren’t fully repaid at the end of the repayment period (typically 20 to 25 years).

What about nonfederal student loans?

While private lenders generally offer fewer options, if any, for student loan forgiveness, that doesn’t necessarily mean you’re stuck with unmanageable debt you can’t afford to repay. Consider speaking directly with your lender or writing them a letter about your options, including reducing monthly payments — the Consumer Financial Protection Bureau even provides a sample letter to get you started.


Beware of student loan forgiveness scams

If you’ve received mail or phone calls urging you to immediately apply for federal student loan forgiveness, or if you’ve been asked to pay up-front or maintenance fees to get help with your loan, you’ve likely been the target of a scam.

Some fake programs will deceive you by going so far as to quote the balance owed on your loan. If you’re looking for help, be sure to play it safe. Always double-check with the U.S. Department of Education beforehand to make sure you’re working with a legitimate loan servicer.

Tax consequences

Debt forgiveness can help free up your financial resources and relieve a major burden. But as we mentioned in the above section on income-based debt repayment and forgiveness plans, it can also involve additional major costs.

In some cases, having your debt forgiven or discharged means you’ll be required to report your unpaid debt to the IRS as ordinary income. That could translate to a significantly higher tax bill.

Before having any debt forgiven or discharged, be sure to find out whether or not your debt will be taxable. If it is taxable, you’ll want to factor that into your decision.

Credit card debt

Believe it or not, credit card companies may be open to forgiving or negotiating your balances. But — are you sensing a theme here? — credit card debt forgiveness is not a magic pill and may come with some pretty serious risks attached.

Let’s look at a couple of options you should be aware of.

Debt management

If you need help repaying your credit card debt, a nonprofit credit counseling agency (not to be confused with a “credit repair” company) may be able to help you find a better payment plan or even reduce part of what you owe.

Setting up a debt management plan, or DMP, often involves making just one monthly payment toward all your debt, including credit cards as well as some of your student loans and other bills, according to a payment schedule the credit counselor makes with your creditors. The credit counseling agency typically oversees a DMP, using money you deposit with them to pay off your debts.

But this special option comes with some limitations and consequences that are important to understand.

  • You may be subject to restrictions on using credit and opening new credit accounts while you’re enrolled in the plan.
  • A DMP may also negatively impact your credit scores in the short term, as creditors may report that you aren’t paying back money in the manner originally agreed upon.

Still, the long-term effects of getting out of debt and establishing financial responsibility could be worth it.

Debt settlement

Credit card debt settlement involves negotiating with your credit card company to pay less than what you owe, and is often arranged by a third party. This third party takes over communication with your credit card company and charges you a monthly fee.

But watch out — debt settlement agencies often require you to stop making your debt payments directly to your credit card company, which could negatively impact your credit reports and scores. Not only will you potentially be subject to late fees, but missing just one payment on a credit card or loan can result in a major hit to your credit scores.

Withholding payment over the long term can cause your debts to turn into collections accounts, further harming your credit and putting you in danger of being sued for repayment.

You’ll also want to be aware of these other potential downsides.

  • You’ll likely be charged high fees for debt settlement services and you may be taxed on the amount of debt you don’t pay back.
  • Debt settlement scams abound, and some of the less reputable companies may not deliver on any guarantees they might make.
  • Just because you’ve got the credit company off your back doesn’t mean you’re in the clear! Most debt settlement programs require setting aside money in a special savings account on a monthly basis. If you can’t make your monthly payments, you may end up dropping out of the program — and you’ll still be on the hook for your unpaid debts.

For many people, the benefits of hiring a for-profit third party for debt settlement don’t make it more appealing than the alternatives, for example, negotiating with your creditors on your own.

Mortgage debt

As with student loans, the federal government generally offers a greater number of options for mortgage debt forgiveness than you’ll find through private lenders.

FHA homeowners may have access to a variety of programs to help prevent foreclosure or provide other assistance. Among these is the Home Affordable Modification Program, which if you qualify may reduce both your monthly payments and a significant portion of your total loan balance.

The Principal Reduction Alternative program, an option available through the Department of Housing and Urban Development, can help homeowners by reducing the total balance owed on a mortgage when it’s significantly higher than what the home is worth.

Learn more about which HUD programs you may qualify for by checking out the HUD Making Home Affordable site.

You can also reach out to your lender directly to ask what help is available.

A note on bankruptcy

If you’ve explored all your options and find you’re simply unable to repay your debts, you may also be considering declaring bankruptcy — just keep in mind that doing so may have some serious ramifications, including lowering your credit scores.

Filing for bankruptcy may provide a few options for overcoming unmanageable debt. A Chapter 7 bankruptcy, for example, may require that you liquidate some of your assets to pay your creditors, but it might be one of the only viable paths to debt forgiveness for some.

Chapter 13 bankruptcy, on the other hand, allows you to keep your physical property, but requires you to make a single monthly payment toward your debt for a period of three to five years after which your debts are discharged. Chapter 13 may involve additional costs and requirements, including paying a lawyer and completing other prerequisites, like mandatory credit counseling by a government-approved organization within six months before you file.

Keep in mind that, while bankruptcy may help relieve your debt obligations, it may also impact your credit for years. Make sure you do your research before making any decisions about filing for bankruptcy.

What should I know before considering debt forgiveness?

If a potential solution to solving debt problems sounds too good to be true, it probably is.

Some companies promise to help you avoid or reduce your debt payments — for a fee, of course. Before signing documents from or sending money to a third party, check the company’s rating with the Better Business Bureau.

Be prepared to walk away if anything smells fishy. Any organization you work with should be able to provide you with clear, time-bound outcomes, and explain how all your costs will add up over the total duration of your repayment — and all in writing.

Take a little time to weigh the other pros and cons, too. Can you afford to pay taxes on any debt that’s forgiven or discharged? If you’re setting up a repayment plan or a settlement plan, how long will it take to reach a payoff date and will the extra costs, like additional interest, be manageable? Make sure to crunch the numbers and find the option that’s most financially beneficial.

Bottom line

If you feel like you’ll never be able to repay all the debts you owe, resist the temptation to bury your head in the sand. Ignoring your bills won’t make them go away, but developing a plan may give you hope and a fighting chance.

Start by reaching out to your creditors to discuss the debt forgiveness or repayment plans available to you. A nonprofit credit counselor may also help you carefully and objectively explore your various options, including bankruptcy.

There may not be a quick fix, but if you weigh the benefits against the costs, you may just come up with a plan for managing your debts that really works for you.

About the author: Sarah C. Brady is a San Francisco–based financial consultant, workshop facilitator and writer. In addition to writing for Credit Karma, Sarah writes for Experian, LendingTree, Magnify Money, MSN News and more. In her … Read more.