What Is Credit Card Debt Forgiveness And How Does It Work?
When you’re sinking in a sea of credit card debt, any potential life preserver is a welcome sight. Credit card debt forgiveness offers the hope of ending your debt crisis by allowing you to settle obligations for less than you actually owe.
Credit card companies sometimes are willing to consider this option if your debt becomes overwhelming, and you simply can’t pay back all that you owe. While it’s unlikely that your creditor will forgive all of your debt, they might be willing to let a portion of the debt slide.
“The borrower can settle a debt for a fraction — often a small fraction — of what they owe,” says Anurag Gupta, a professor of banking and finance at the Weatherhead School of Management at Case Western Reserve University in Cleveland.
However, such debt forgiveness also has significant downsides that must be weighed before pursuing this route.
Debt Forgiveness Vs. A Debt Write-Off
Even if you’re struggling to make payments, debt forgiveness is unlikely to be an option for you right away. Instead, your creditor will wait to see if you repay your debt. They may work with you on creating a repayment plan to pay back your debts more gradually in the hope that eventually, you’ll pay the full amount.
But at some point, the lender may determine that you’re unlikely to ever pay off your debt. A lender is especially likely to reach this conclusion after you’ve missed several payments.
When this happens, the lender may write off the debt as uncollectible and remove the debt from its books. The Federal Trade Commission says lenders are likely to write off your debt if you fail to make a payment on it for a period of 180 days.
It’s important to note that at this point, the lender has simply written off the debt, not necessarily forgiven it. While a debt write-off may seem like the debt relief you seek, however, the debt itself still exists. A write-off typically doesn’t resolve your debt problem. Instead, it’s often the end of one chapter but the beginning of another.
After writing off your debt, the lender may turn around and sell the obligation to a debt collector. At this point, the debt will regain life, as the collector tries to get you to pay once again. The collector may even file a lawsuit against you in an attempt to get you to pay up. If the collector wins the lawsuit, it’s possible your wages could be garnished to pay the debt.
What Is Debt Forgiveness?
Debt forgiveness is a step beyond a write-off. In this instance, the lender agrees to accept a payment that is less than the full amount of what you owe. The remaining balance is then forgiven.
This is a better situation than a debt write-off because, at this point, you no longer owe the lender anything. However, that doesn’t mean debt forgiveness offers a no-risk, free ride to the borrower.
For starters, the lender is likely to notify the credit-reporting agencies that it settled the debt for less than the full amount. This can result in a negative notation in your credit report that will cause your credit score to dip.
“It does damage credit for a period of seven years,” Gupta says.
In addition, just because the debt was forgiven doesn’t mean it’s not taxable. The IRS considers forgiven debt to be income, and you’ll owe federal taxes on the amount. State authorities also are likely to expect you to pay taxes on the amount of debt that was forgiven.
Your lender likely will send you a Form 1099-C, Cancellation of Debt that shows exactly how much of your debt was forgiven. The lender will also notify the IRS, so there’s no way around your obligation.
While there are situations where you may not owe tax on forgiven debt, your default should be to assume that you do. If you are unsure about what you do or do not owe, talk to a tax adviser or other professional.
How Does Credit Card Debt Forgiveness Work?
Typically, credit card debt forgiveness can occur either through direct negotiation or a bankruptcy filing.
“The direct negotiation can be done either by the borrower themselves or through a representative,” Gupta says.
Some borrowers reach out to the card company to negotiate a settlement amount which the lender is willing to accept to discharge the debt. “It is often a small fraction of the total debt due,” Gupta says.
Others prefer to use a debt settlement company. This method can have both advantages and disadvantages.
“Negotiation through a professional debt relief company might get the person better terms from the card company, but it will involve paying a fee to the debt relief company,” he says.
Finally, in some cases, borrowers may simply throw in the towel and declare bankruptcy, hoping to get debt forgiveness that way. However, this is a drastic step that can have long-term ramifications for your finances. And Gupta says this approach is “a bit risky” and might not work as well as you hope.
“The final terms will be decided by a judge, so there is much less control over that process once it starts,” he says.
What Are The Consequences Of Having Your Debt Forgiven?
There are situations where seeking debt forgiveness is a borrower’s best option. Even if this seems like the right option for you, make sure you don’t rush into it. “In general, debt forgiveness is something a borrower should seek as late as possible,” Gupta says.
Waiting to negotiate can give you more leverage in negotiations. “The chance of settling for a lower amount is higher if it is done later,” Gupta says.
In fact, borrowers often can benefit from waiting until the card issuer has sold the debt to a collector and the lender has written the debt off its balance sheet.
“These delinquent debt sales usually happen for pennies on the dollar,” Gupta says.”As far as the collection company is concerned, as long as they can collect something higher than what they paid, they will make a profit.”
For that reason, a borrower may have a greater chance of being able to negotiate better terms with the debt collector rather than with the card issuer, “though the process may be more unpleasant,” Gupta says.
It is true that if you’re unable to make your payments, waiting to negotiate might result in damage to your credit score. But this is often not a major concern for borrowers who have accrued a large amount of credit card debt and simply cannot pay it back.
“It is highly likely that they have already been late on several payments and have been subject to several missed payment deadlines and penalties,” Gupta says. “Their credit, therefore, is likely already damaged.”
Debt Forgiveness And Credit Report
Debt forgiveness can stay on your credit report for up to seven years. But the consequences might not be as great or lasting as borrowers fear, given the lax credit standards of many credit card issuers and the multiple ways available to borrowers hoping to rebuild credit.
“They are likely to start getting new credit offers much sooner than the seven years it will take for this negative information to drop off from their credit report,” he says.
Will credit card companies really forgive your outstanding balance? See how credit card debt forgiveness could work to get you out of debt.
At National Debt Relief, we take pride in empowering people to regain their financial stability through our proven debt relief program. Contact us and talk to a financial expert who will work with you to find the best option to settle your debt and help you achieve financial independence.
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