Debt Forgiveness: Understanding All of Your Options

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Debt can be a dangerous thing. Even if you do your due diligence to make sure you can afford to repay the money you’re borrowing, you might experience changes in your life that can impact your ability to keep up with the payments.

“People don’t wake up one day and decide to default on their financial obligations,” said Howard Dvorkin, CPA, chairman of Debt.com and author of “Credit Hell: How to Dig Out of Debt.” “Usually, they lose their job, get divorced, have kids or experience something else that throws them off and makes it really difficult to catch up.”

While there’s no magical way to wipe out your balances, debt forgiveness programs might be a lifeline out of an unmanageable situation. However, borrowers need to be aware of the pitfalls of debt forgiveness to see if it’s the right option for them.

Here are some debt forgiveness programs to consider, along with the red flags you should watch out for.

Student loan debt forgiveness

When it comes to student loans, the average amount owed is $32,731. That amount of debt can put some borrowers in hot water, especially if their first few jobs don’t pay as much as they’d hoped. But getting rid of your student debt may not be easy.

First, debt forgiveness depends on what type of loans you have: federal or private. Federal student loans come from the government, whereas private student loans come from banks, other financial institutions or other organizations. Unfortunately, it can be difficult, if not impossible, to get private student loans forgiven.

“But there are programs in effect with the government that give federal student loan borrowers the ability to pay off their loans in an organized manner, or forgive their debt entirely,” said Dvorkin.

The main debt forgiveness programs for federal student loans include income-driven repayment plans, Public Service Loan Forgiveness and occupational loan forgiveness. Here’s how they work.

Income-driven repayment (IDR)

With IDR plans, like Income Contingent Repayment (ICR), Income Based Repayment (IBR), Pay As You Earn (PAYE) and Revised Pay As You Earn (REPAYE), you’ll pay 10% to 20% of your discretionary income to your loan provider for 20-25 years. As long as you’re still in compliance with the program by the time it ends, the remaining balance on your student loans will be forgiven.

You can apply for an IDR plan through StudentLoans.gov. Make sure that you’ve gone through the application process and gotten approved for the repayment plan. Otherwise, the monthly payments may not count toward student loan forgiveness.

You will also need to recertify for the program each year by providing updated information about your family size and income. You will need to pay taxes on the forgiven amount.

Public Service Loan Forgiveness (PSLF)

PSLF forgives the balance on Federal Direct Loans and Federal Consolidation Loans for borrowers who make 120 qualifying payments while employed full-time in public service (either through the government, a 501(c)(3) nonprofit or another qualified employer).

To qualify, complete and submit the Employment Certification Form to FedLoan Servicing every year and whenever you start working for a new employer. After you’ve made 120 qualifying payments, you will need to apply for PSLF using this form.

While payments made on the 10-year Standard Repayment Plan do qualify for PSLF, you will have no balance left to forgive by the time you make 120 qualifying payments, so make sure you’re on an IDR plan. Stay up-to-date with news about PSLF, as well. The Trump administration has attempted to get rid of PSLF in the past.

Occupational student loan forgiveness

There are a variety of other student loan forgiveness programs for people in specific professions, such as teachers, nurses, doctors and lawyers. Eligibility and application requirements vary by program. So, look into the specific program you’re considering to learn more.

Be mindful, however, that some programs cap the total amount that can be forgiven. You may also need to pay taxes on the forgiven amount.

Tax debt forgiveness

If you’re struggling to pay your taxes, don’t ignore the problem.

“Tax debt is the nastiest type of debt. The government has an unbelievable amount of power over you — they can swipe your tax refunds to pay for your debt, garnish your wages, all sorts of things,” said Dvorkin.

An Offer in Compromise can be used to get some of your tax debt forgiven. It allows you to “settle your tax debt for less than the full amount you owe,” according to the IRS.

Offer in Compromise

You can check your eligibility for an Offer in Compromise by using this pre-qualifier tool. The IRS also provides an Offer in Compromise Booklet, which offers instructions and forms you can fill out to submit an offer.

The IRS will consider your ability to pay, income, expenses and asset equity to determine if your full tax liability would be impossible to pay or create a financial hardship. Its website states that it generally approves an Offer in Compromise if the proposed amount is equal to the total it can expect to collect from you within “a reasonable period of time.”

Dvorkin estimates that only 25% of offers in compromise are approved, so it might not be an option for everybody.

Mortgage debt forgiveness

The main ways to access mortgage debt forgiveness are foreclosures and short sales. Unfortunately, both come with a very serious consequence: The loss of your home.

Foreclosure

If you fail to repay your mortgage, the lender may choose to take ownership of your home and sell it through a legal remedy known as foreclosure. The lender may also need to take you to court or through other foreclosure procedures.

This process generally starts when you’re delinquent on payments for at least 90 days, and you may have several more weeks or months to get current on payments or negotiate a deal with your lender.

If your lender doesn’t recoup the balance of your mortgage through the sale of your home, it may try to collect the remaining amount from you. Foreclosure will have a negative effect on your credit report for seven years, making it difficult for you to get a home loan and other types of credit.

Short sale

Another way to potentially get out of a mortgage is through a short sale. This is when you sell your home for less than you owe, and try to get the balance forgiven by the lender.

You will need to get in touch with your lender to apply for a short sale. But any amount of your mortgage that’s forgiven through a short sale may be considered taxable income by the IRS. Like a foreclosure, a short sale will damage your credit score.

Credit card debt forgiveness

Has your credit card debt spiraled out of control? There are a few options to consider that may offer you debt forgiveness or reduce the total amount you owe.

Negotiate with creditors

If you’re having trouble paying your credit card bills, you can call the creditor directly to try to get some of the debt forgiven.

“Most lenders are used to people not paying their bills. They have departments and internal programs available to help borrowers,” said Dvorkin.

If you wish to explore this option, reach out to your credit card company. If your debt has gone to collections, you can also try to negotiate a lump sum payment with the collections company. You will usually need to have the money ready if you try to settle.

Lenders may not be receptive to negotiating a settlement with a customer who is current on payments, however, even if that borrower knows they can’t keep up for much longer, said Dvorkin. “The longer you’ve defaulted on the debt, they better off you’ll be in negotiating with creditors because they’ll be more eager to make a deal with you,” he said. Your credit score may take a hit during that time. The forgiven debt may also be considered taxable income.

Debt settlement programs

A debt settlement company can negotiate down credit card debts on your behalf. Generally, these companies can also pursue settlement for other unsecured debts, like medical bills.

When you’re pursuing debt settlement, you will usually have to stop paying your credit card bills and instead start putting money away in a separate bank account. The debt settlement company will then offer creditors a lump sum from those savings to settle your debt for less than you owe. The process can take a couple of years.

However, debt settlement programs come with many potential downsides. You may incur high fees from the debt settlement company. Your credit score may plummet when you stop paying your bills. New York Attorney General Letitia James warns that many debt settlement companies make false promises that leave customers worse off.

What about bankruptcy?

Bankruptcy is another potential solution to getting out of some or all of your debt. Chapter 7 bankruptcy could offer total debt forgiveness depending on what you owe, while Chapter 13 bankruptcy would require you to repay some of your debt. It’s worth noting that federal student loans may not be as easy to get discharged in bankruptcy.

Before you can file for bankruptcy, you will need to undergo credit counseling from an organization approved by the government, according to the Federal Trade Commission (FTC). You can then start filing the necessary documents, either on your own or with a lawyer.

Bankruptcy isn’t free — on average, expect to incur at least $1,300 in out-of-pocket costs. The process can also take two to six months, on average. Debts cancelled through bankruptcy may have tax implications. Bankruptcy will also damage your credit score and stay on your credit report for seven to 10 years.

Alternatives to loan forgiveness

Debt forgiveness can come with negative consequences. Before you go down that road, it’s worth considering alternative ways to make your debt more manageable.

Debt consolidation: You can use a new loan to consolidate other types of debt, potentially at a lower interest rate. The consolidation loan will also condense multiple bill payments into one, simplifying your finances.

Debt refinancing: Refinancing is another way to get your debt under control. You may be able to get a home equity loan or a personal loan to pay off other types of debt.

0% interest credit cards: You may be able to transfer the balance from one credit card to a new credit card that offers a 0% interest rate within a promotional period. This can help you avoid the interest you would have collected on the debt if it stayed with the original creditor. You may need to pay a fee of 3% to 5% to transfer the balance, though.

Even though debt forgiveness can have some consequences, it can offer some borrowers the fresh start they need to get their finances in order. Make sure you understand the pros and cons of each type of debt relief so you can choose the best option for your needs.

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