What is debt forgiveness?

Every year, more Americans find themselves in debt. According to the Federal Reserve Bank of New York, Americans had amassed $17.8 billion in total household debt as of Q2 of 2024. With rising inflation, it’s no wonder Americans are looking into debt relief interventions such as debt forgiveness. 

Common debts people want forgiveness for often include credit cards, student loans, medical bills, mortgage payments and tax obligations. Understanding how debt relief and debt forgiveness can help you is just one step. You should also know how the debt relief will impact your credit score, taxes and future credit applications. 

How debt forgiveness works

Debt forgiveness happens when a creditor is willing to write off debt. This may be a partial or full pardon of the amount owed and can happen under various conditions, such as government initiatives, financial hardship or debt relief programs. 

Debt forgiveness is also referred to as debt cancellation or debt relief, but the latter describes an entirely different process of eliminating debt. 

Lenders apply debt forgiveness in several ways, including through directly negotiated settlements or government programs. You can also approach industry professionals such as debt counselors to assist with repayment plans.  However, it’s important to keep in mind that debt forgiveness is relatively rare.

“Unless you target specific programs like Public Service Loan Forgiveness, it’s best not to count on any form of debt forgiveness,” says R.J. Weiss, certified financial advisor and the CEO of The Ways to Wealth. “While you may hear more about it during election cycles, it’s important to take these promises with a grain of salt. Additionally, it’s rare for private companies to flat-out forgive debt outright—this typically only happens in bankruptcy. In the private sector, if any form of debt relief is offered, it often comes with significant strings attached.”

Types of debt forgiveness

The type of debt forgiveness can vary depending on the debt you want forgiven. You may also need to meet certain qualifying criteria before lenders will consider loan forgiveness. 

Student loan debt

With the rising costs of education, many graduates face the daunting task of repaying substantial student loans. The average student owes $29,100 in student loan principal.

Depending on your job, where you studied and how much of your loan is already paid off, you may have a few choices for student loan debt forgiveness. With student loans, there are generally two options available for student loan forgiveness. 

The first is the Public Service Loan Forgiveness Program or PSLF. This initiative allows debt forgiveness if you work for the government or a nonprofit organization and you’ve met the following criteria: 

• You’ve already made the equivalent of 120 months of qualifying payments under a repayment plan.
• You’re working full-time for qualified types of employers.

The other option is the Income-Driven Repayment (IDR) Plan, which caps your repayments according to your income and family size. After 20 or 25 years of repayments, the balance of the loans may be forgiven. The plans under this category include: 

Some states and employers offer help with student loan debt. However, not all student loans qualify for forgiveness, especially private ones. While student loan forgiveness can be a huge relief, it’s critical to understand the details of your particular loan.

Pros

• You may be able to pay less on your student loan repayments.
• Several federal debt forgiveness programs are available.
• Some career paths may offer specialized forgiveness programs.
• Even partial forgiveness can provide significant relief.

Cons

• Private student loans typically do not qualify for forgiveness.
• Forgiveness processes usually take time.
• Eligibility criteria are stringent.
• Individuals who have defaulted on loans are generally ineligible for forgiveness.

Medical debt

Unexpected medical expenses can accumulate quickly, leading to overwhelming debt. Fortunately, there are processes to help with this type of debt through medical bill debt forgiveness programs.

If you are struggling with medical debt, contacting the medical facility where you incurred the debt is a worthwhile first step. You can inquire about their financial assistance policy, which is often referred to as charity care. These programs typically consider your income when determining eligibility.

The hospital may significantly reduce your bill or even forgive it entirely. Nonprofit hospitals are legally required to have assistance policies in place.

Common qualifying criteria for medical debt forgiveness include: 

• Income: The extent of the forgiveness will depend on the applicant’s income and finances. Those in financial hardship are more likely to qualify for full debt forgiveness. 
• Uninsured or underinsured: Those without insurance or whose insurance doesn’t cover all the expenses may qualify for forgiveness. This is especially true for catastrophic medical events where even reasonable health insurance won’t cover the costs. 
• No source of payment: When a debtor has no suitable source of funds, debt forgiveness might apply. 

In 2022, the three major credit bureaus announced changes in reporting medical debt. Paid medical collections are now removed from credit reports. Unpaid medical collections won’t appear on credit reports unless they’ve been in collections for at least a year. Furthermore, medical debts under $500 no longer appear on credit reports. 

These changes offer relief to individuals burdened by medical debt and lessen its impact on credit scores.

Pros

• Even if you do not qualify for complete forgiveness, financial assistance may be available.
• Medical debt forgiveness is awarded on a sliding scale. There is no set limit for how much you need to earn.
• If you don’t qualify for forgiveness, there may be ways to get your bill reduced.

Cons

• Securing medical debt forgiveness can be time-consuming and laborious, with no guaranteed outcomes.
• You may need to provide the medical institution with documentation like tax returns and pay stubs to prove your need.

Tax debt

Unpaid taxes can result in significant financial strain. The Internal Revenue Service (IRS) provides several options for taxpayers facing financial hardship. One common method is the Offer in Compromise (OIC) program, which allows taxpayers to settle their tax debt for less than the full amount owed.

Installment agreements provide another avenue, allowing taxpayers to pay their debt over time in manageable monthly payments. Additionally, the IRS may offer penalty abatement or other forms of relief for eligible individuals.

Pros

• Get immediate relief from the burden of owing taxes.
• Potentially settle your tax debt for less than the full amount owed.
• Avoid harsh collection actions such as wage garnishment or asset seizure.

Cons

• Tax debt forgiveness may have implications for future tax filings, and forgiven debt may be considered taxable income.
• Engaging with the IRS can be complex and time-consuming, requiring careful consideration of available options and potential drawbacks.

Mortgage debt

Technically, mortgage debt isn’t forgiven unless there is a deficient balance after the sale or foreclosure of a property. If a borrower is struggling to make payments, the options are:

• Bankruptcy: Certain types of bankruptcy allow you to keep your assets by restructuring your payments, but the debt won’t be forgiven.
• Foreclosure: When you’re unable to make the agreed payments and loan modifications or bankruptcy are no longer an option, the bank may move to repossess your home and collect whatever it can by selling it. 
• Loan modifications: The lender agrees to modify your loan to reduce your monthly payment. One way they can do this is by extending the term of the loan. 

If the lender agrees to any degree of debt forgiveness through loan modification or foreclosure, there are a few pros and cons to consider.

Pros

• Loan modification may allow you to avoid foreclosure and its damaging effects on credit.
• Reduce or eliminate a significant portion of mortgage debt if you owe more than the property is worth during foreclosure.
• Get relief from the stress and uncertainty of struggling to make mortgage payments.

Cons

• Mortgage debt forgiveness may have tax implications, as forgiven debt can be considered taxable income in some cases.
• Homeowners may face challenges in qualifying for loan modifications and navigating complex lender negotiations.
• Foreclosure damages your credit score and remains on your report for seven years.

Credit card debt

Credit card forgiveness is a rarity. Credit card issuers typically expect individuals to repay the amount borrowed, and high-interest credit card debt can be difficult to overcome.

While forgiveness typically isn’t an option, you can pursue debt relief options such as: 

• Bankruptcy: You can file for bankruptcy, which in certain cases includes full or partial debt forgiveness. 
• Debt consolidation: You can consider taking out a personal loan or opening a zero-interest credit card to transfer your balance and pay off your debt. 
• Debt management plans: A debt counselor will work with your lenders to create a suitable repayment plan. They won’t negotiate a lower settlement amount but will request reduced interest rates and fees to help you get out of debt faster. 
• Debt settlement: This is when you negotiate for the debt to be settled for a lump-sum to guarantee payment. This process severely damages your credit score because you must miss several payments before lenders arec willing to negotiate.
• Hardship programs: Some lenders may agree to assist with loan forgiveness if you can prove severe financial hardship, such as becoming disabled. 

Consider the pros and cons of credit card forgiveness before pursuing this route. 

Pros

• Credit card refinancing may be available at a lower interest rate, saving you money in the long term.
• A consolidation loan simplifies your finances by reducing several credit card payments to just one monthly payment.

Cons

• Debt management companies often charge fees, increasing how much money you owe overall.
• If you don’t take quick action with a debt consolidation loan, your credit card payments may become overdue and hurt your credit score.

Pros and cons of debt forgiveness

While debt forgiveness can offer relief from overwhelming financial burdens, it’s essential to understand the potential benefits and drawbacks before you choose this path.

Benefits of debt forgiveness

Debt forgiveness can provide much-needed relief to individuals struggling with overwhelming financial burdens. Some of the benefits include:

• Credit score repair: While you might experience a slight dip in your credit score, it’s only temporary. Loan forgiveness could drop your overall debt-to-income ratio, which may improve your long-term chances of qualifying for further credit. Note that this does not apply to debt settlement, as the missed payments are generally required before negotiating a settlement, so your credit score will be in bad shape before and after settlement. 
• Faster repayments: By securing reduced settlements or payment plans, debt forgiveness empowers you to pay off your debt more quickly.
• Reduced stress: Debt forgiveness can eliminate the stress of dealing with aggressive debt collectors, providing relief and allowing you to focus on rebuilding your financial health.
• Save money: Forgiven debt often means paying less than the amount owed, saving borrowers money in the long run. In the case of debt settlement, fees and interest may be added, so the amount of money saved can vary.

Downsides of debt forgiveness

Having less debt to pay off certainly sounds appealing. However, there are some negative repercussions to consider:

• Credit score decrease: Debt forgiveness may negatively affect credit scores, making obtaining future loans or credit challenging. The forgiven debt may show up as settled accounts on the credit report, which means the lender accepted less than the full payment for the loan. A debt settlement also causes your credit score to be lowered for years before and after because of the missed payments and settlement.
• Tax implications: Forgiven debt may be considered taxable income, potentially resulting in a hefty tax bill.
• Costly: Engaging with debt relief companies can cost money, exacerbating financial difficulties.
• High risk of scams: Debt forgiveness and debt repair scams can trap vulnerable customers by promising unrealistic results, further complicating their financial situation.

Do debt relief programs hurt your credit?

While debt relief programs can provide much-needed relief, they may hurt your credit score. Depending on the type of debt relief, such as debt settlement, your credit score could be hurt for years before and after.

However, timely payments and responsible financial management can help mitigate negative effects, improving your credit over time. 

Alternatives to debt forgiveness

If you don’t qualify for debt forgiveness or simply find it’s not a good fit, there are alternative debt management options to help you repay and manage your debts:

• Debt consolidation: Debt consolidation is merging multiple debts into a single loan, typically with a lower interest rate. This can simplify payments and potentially reduce overall debt.
• Credit counseling: Seeking guidance from accredited credit counseling agencies can help you create realistic budgeting strategies and debt management plans.
• Credit repair: Credit repair includes identifying negative errors on your credit report and correcting them. You can do this by accessing your free credit report and disputing errors or by working with a credit repair company. 
• File for bankruptcy: In extreme cases where debt is insurmountable, filing for bankruptcy may offer a fresh start by liquidating assets or establishing a repayment plan.

The bottom line

Debt forgiveness allows you to resume your financial journey with a clean slate. That said, it’s important to know what you’re getting into, how to prepare your application and under what circumstances you may apply. 

You should also be aware of the effect of these options on your credit score and how this could impact your ability to get financing in the future.