How Does Debt Forgiveness Work? | CreditShout

How Does Debt Forgiveness Work?

By Kaitlin T / October 27, 2011
using debt consolidation to eliminate debt

Q: I’ve heard some friends talk about debt forgiveness. What exactly does this mean?

A: Debt forgiveness happens when a creditor decides that a debtor is not going to pay back his or her debt, and therefore decides to write it off.

This usually happens when the person gets behind in their payments. It is often preceded by a long period of trying to collect the debt, which may include harassing phone calls and letters.

The creditor has the right to sue you, but sometimes it costs more to sue than the debt is worth, and it simply isn’t worth it to sue.

Debt forgiveness doesn’t always mean forgiving the entire amount of the debt. The lender may work out a payment plan with you instead. Or the lender may forgive a portion of the debt to enable you to keep paying without getting in over your head.

They would rather you keep paying something than give up altogether, or worse, declare bankruptcy so they can’t come after you.

If you find that you’ve fallen behind, the best thing to do is to try to work out some kind of payment plan, or negotiate a lowered interest rate or smaller payments.

Explain to your creditor that you want to keep paying, but you simply don’t have the money.

This doesn’t work with all debt collectors, so you may need to call a credit counseling service. Stay away from the ones that advertise on TV, since many of them are just trying to make money off of you. Instead, look for one with good reviews such as Care One Debt Relief.

One thing you have to keep in mind is that any debt that is forgiven will be counted as income for tax purposes.

For example, if your credit card company decides that you’re not going to pay off your credit card and forgives $5,000 of debt, you’ll have to pay taxes on that $5,000. This can happen with a short sale or foreclosure, too, although there is currently a law in place that suspends tax liability for debts forgiven on your principal residence until the end of 2012.

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