What is Debt Forgiveness and What are its Costs?

What is Debt Forgiveness and What are its Costs?

It can be burdensome to awake to another day of indebtedness. You promised yourself that you’d never have such obligations, yet here you are. And you may be wondering how you’re going to get yourself out from under them. 

Now, you do have options to help with your debt. And sometimes debts like yours are forgiven. But there is no free lunch, as they say. There are usually costs that accompany debt forgiveness. 

So, what is debt forgiveness and what are its costs? Read on.

What is Debt Forgiveness?

There are several forms of debt forgiveness. For example, your home may be foreclosed upon, or you may have to participate in a “short sale” in which the remaining mortgage isn’t covered by the sales price. Here, the remaining debt may be forgiven by the lender, all or in part.

Regarding federal student loans, say you’ve kept up with your payments over the term of your agreement. Usually, the period is between 10 and 30 years. Once that period is over, any loan balance may be forgiven.

There’s also debt settlement, a financial strategy that’s also called debt relief. The process involves hiring a firm such as Freedom Debt Relief to go to each of your creditors, usually credit card issuers, to see if they would accept a portion of what you owe as a lump sum payment in full. The payment derives from savings you’re asked to accumulate in lieu of paying your creditors directly. Creditors are usually amenable since they know that if your file bankruptcy – your next available option – they stand a good chance of getting nothing. 

For example, if you owe $15,000 on your cards, and you ultimately agree to settle the obligation for $7,500, the remaining $7,500 is essentially forgiven. You can get such help at FreedomDebtRelief.

Really, any debt can be forgiven in whole or in part – but that’s wholly up to the lender. To be sure, though, lenders are not Santa Claus. For them to forgive your obligation, there must be something in it for them. If you’re able to satisfy your liability, there’s little chance it’ll be forgiven. The situation is a little different for student loans, since those balances may be forgiven under certain circumstances – your school was negligent about something related to your loan, for instance, or if you’ve declared bankruptcy. But outside of those kinds of circumstances, you are still responsible for loan repayment.

The Cost of Debt Forgiveness

When it comes to debt forgiveness, there are two chief costs involved. Those include the cost of the settlement – the part of the obligation you do pay – as well as the tax you shell out on forgiven debt.  In the case of debt relief, you also must pay for the service, but not until a settlement is reached. Those fees usually run between 15-25% of either the original debt amount or the amount you’ve agreed to pay.

Keep in mind, too, that forgiven debt is usually deemed taxable income. In fact, any time more than $600 is forgiven, the creditor must send you a 1099 form stating the forgiven debt amount (this is because the creditor will be claiming your forgiven debt as lost income). You are required to subsequently add the amount forgiven to the “other income” portion of your taxable return for that year. Note that if your forgiven debt totals less than $600, you still must claim it on your taxes. You just won’t get a form from the creditor.

Having said that, your forgiven debt may not be taxable if:

  • The debt is due to personal bankruptcy
  • Your debts outweigh your assets
  • You made all required payments on a career-specific student loan repayment plan

If you’re unsure about the impact of the forgiven debt on your tax return or income bracket, it’s best to contact a tax professional.

Ultimately, there are usually costs associated with debt forgiveness, in some form or fashion. And while that is true for strategies such as debt settlement, you may find that the benefits of a fresh start may be worth the cost. Run the numbers and do what’s best for you.

Chris Evan was born in Quebec and raised in Montreal, except for the time when he moved back to Quebec and attended high school there. He studied History and Literature at the University of Toronto. He began writing after obsessing over books.

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