Credit Card Debt Forgiveness: What You Need to Know

Credit card debt forgiveness, also known as debt settlement, involves negotiating with creditors to reduce the amount owed on your credit card balances. While it can provide relief from overwhelming debt, it may have significant consequences, including damage to your credit score, tax implications, and potential legal actions from creditors. It’s crucial to fully understand the terms and consequences before pursuing debt forgiveness and to explore other options such as debt management or consolidation.

By the end of 2023, American consumers had more than $1.13 trillion in credit card debt. If you have credit card debt and you’ve been struggling to repay your creditors, don’t panic—you may qualify for some type of credit card debt forgiveness. Here’s what you need to know about this option for managing your finances.

What Is Debt Forgiveness?

Debt forgiveness is when a lender reduces or eliminates the amount you owe. For example, a credit card company may agree to forgive $400 of a $1,000 balance. Credit card debt forgiveness makes it a little easier to manage your finances, as it wipes away some of your debt, leaving you with more money for debt repayment or household expenses.

Debt forgiveness has the following benefits:

• When you reduce a credit card balance, you only pay interest on the remaining amount due. As a result, debt forgiveness may help you save hundreds or even thousands of dollars, depending on how much you owe and how long it takes to pay the account in full.
• If a creditor forgives your entire debt, you can use the minimum monthly payment to catch up on bills or pay off your other debts faster.
• You don’t have to stress about paying back the original balances on your cards.

Ways to Have Your Debt Forgiven

If you’re struggling to make your credit cards on time, you may qualify for one of the following types of debt forgiveness.

Negotiate With Creditors

The easiest way to reduce your account balances is to negotiate with creditors. Depending on how much you owe and how long it’s been since your last payment, a credit card company may be willing to accept a settlement for less than the amount owed. For example, it’s possible to negotiate a settlement of $250 on a balance of $500.

Before you contact a creditor, calculate how much you can afford to pay. If you only have $300 available, you know you can’t accept a settlement for any more than that. When you’re ready to call, follow these steps:

1. Explain your financial situation. The information you provide may affect the creditor’s willingness to forgive your debt. For example, if you’re unemployed, a representative may be willing to settle for a lower amount because they know you don’t have any income.
2. Let the creditor know how much you can afford to pay. Offer a little less than you have available. If the creditor agrees, you’ll have a little cash left over to tackle another debt.
3. If the creditor agrees to your proposed settlement, ask the company to email you a copy of the agreement. The document should state that the creditor is willing to accept the settlement amount as payment in full.
4. Pay the agreed-upon amount. If possible, mail a money order so the creditor can’t access your bank account information. Each money order also comes with a detachable receipt, making it easy to keep track of who and how much you’ve paid.

Participate in a Debt Relief Program

If you’re too busy to negotiate or you just don’t feel confident doing it on your own, consider signing up for a debt relief program. This type of program helps reduce the amount of debt you owe, giving you a little more breathing room.

Once you sign up, a program representative contacts each of your creditors and attempts to negotiate a settlement. Just like when you try to negotiate settlements on your own, there’s no guarantee every credit card company will agree to reduce your balance.

Some debt relief providers advise their clients to stop making minimum monthly payments on their credit cards. The reason for this recommendation is that some creditors are more willing to negotiate if you’re already several months behind. However, if you stop making payments, your credit will likely take a hit, as your payment history accounts for 35% of your FICO® scores.

Debt relief may not be the best approach if you want to preserve your credit scores, but if you’re already behind on your credit cards, there’s no additional penalty for signing up.

File for Bankruptcy

Bankruptcy is a legal process that allows you to eliminate some or all of your debts. In a Chapter 7 bankruptcy, also known as a liquidation bankruptcy, a trustee sells some of your assets and uses the proceeds to repay as much of your debt as possible.

To qualify for a Chapter 7 bankruptcy, you must meet one of the following requirements:

• Your current monthly income is less than the median income for your state.
• You pass a means test designed to determine if an individual is abusing the bankruptcy system.

Under the Chapter 7 bankruptcy rules, you can exempt some of your personal property from the process. For example, there’s a federal exemption of $4,450 for a motor vehicle. If you exempt an asset, the trustee doesn’t sell it.

Chapter 13 is for debtors who don’t meet the requirements to qualify for Chapter 7 relief. If you have regular monthly income, a Chapter 13 bankruptcy allows you to set up a debt repayment plan. The plan lasts three to five years, depending on how much income you earn. Once you complete the payment plan, any remaining debts are discharged.

Filing for bankruptcy has several pros and cons. The biggest advantage is that it gives you a fresh start. Filing triggers an automatic stay, which means creditors must stop their collection attempts while your case is pending.

Bankruptcy also allows you to avoid wage garnishment in the future. Once a debt is discharged, it’s gone forever. The creditor can’t get a judgment against you or start deducting payments from your wages. 

The biggest drawback is that filing for bankruptcy hurts your credit. It can also stay on your credit reports for up to seven to 10 years, depending on the type of bankruptcy you file. When you have a bankruptcy on file, it’s more difficult to qualify for loans, credit cards and other types of credit.

Potential Tax Implications of Credit Card Debt Forgiveness

Debt discharged through bankruptcy isn’t considered taxable income. However, if you negotiate a settlement or have a debt relief company negotiate on your behalf, you may owe income tax on the forgiven amount. For example, if a creditor accepts $400 as payment in full for a balance of $1,000, you may have to pay tax on the $600 difference.

You may be able to avoid the federal tax on forgiven debt if you’re insolvent, which is when your total liabilities exceed your total assets. Someone with debts totaling $25,000 and assets totaling $20,000 meets the definition of insolvency.

If you’re insolvent, seek advice from a qualified tax professional. You may need to file Form 982 with your federal tax return. Your state may also impose income tax on forgiven debt.

Alternatives to Debt Forgiveness

Credit card debt forgiveness isn’t right for everyone, but there are a few alternatives.

Debt Consolidation

Debt consolidation allows you to combine several debts into a single loan, making it easier to manage your finances. For example, if you have credit cards with balances of $500, $2,500, and $5,000, you may be able to consolidate them into a loan for $8,000.

Consolidation loans typically have fixed interest rates, so you don’t have to worry about your rate changing from month to month. Additionally, getting a consolidation loan allows you to make just one payment per month, eliminating the need to juggle multiple accounts.

Budgeting

If you don’t have much debt, budgeting may help you pay it off without having to negotiate settlements or sign up for a debt relief program. A budget estimates your monthly income and expenses, making it easier to identify opportunities to save and pay off debt.

Once you create a budget, you may need to reduce your expenses or increase your income. The more you earn and the less you spend, the more money you’ll have available for credit card payments.

Negotiating Interest Rates

Some credit cards come with high interest rates, making it more difficult to pay off the balances. To reduce the amount of interest applied to your balance, contact your credit card companies and ask for lower rates. There’s no guarantee they’ll agree, but it doesn’t hurt to ask.

Balance Transfers

If you have a strong credit history, transferring high-interest credit card debt to a balance transfer card can help you pay off debt faster. Once you transfer your balances, interest doesn’t start accumulating until the promotional period expires, so you can make payments without worrying about how much interest is building up every month.

The no-interest period may expire within as little as six months, so be sure to pay off the balance before the regular APR kicks in.

If you want to make a plan to improve your financial health, get started with your free credit score and credit report card from Credit.com today.

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