When you are dealing with overwhelming debt and can’t afford to pay it back, that’s when you use strategies like debt settlement or debt forgiveness. For people with low income, a medical emergency or increasing expenses these strategies can really alleviate debt burdens but they work differently and only under certain circumstances, you can use them. In this guide, we will discuss both the options in detail so that you know which one suits you the best.
The Difference Between Debt Settlement And Debt Forgiveness
In debt settlement, you either talk to your creditor directly or use a third party like a debt relief company for an agreement where a certain percentage of your debt is forgiven and you have to pay the rest of the decided amount. However, in debt forgiveness, you don’t have to pay your creditor anything at all and just as the name implies, your entire debt will be forgiven.
It all sounds really alluring but it’s not as easy as it sounds and it definitely isn’t for everyone. There are certain circumstances and eligibility criterias that you have to meet in order to qualify for any of these options.
Understanding Debt Forgiveness
Debt forgiveness, also known as debt cancellation or debt relief is when your creditor just writes off your debt. This happens rarely and under special circumstances like government initiatives, financial hardships or debt relief programs. In order to apply for debt forgiveness, you can either work on a negotiation with your creditor directly or just hire a professional company to do the job for you.
Moreover, debt forgiveness only applies to unsecured debt like credit cards, personal loans or student loans. These loans don’t come with a collateral and you can convince your lender to write them off. However, if you’ve taken up a secured loan like a mortgage or a car loan then you should know that they don’t qualify for debt forgiveness at all.
Types Of Debt Forgiveness
If you want your lender to consider forgiving your loan then there are a few criterias that you have to meet. Here are your options;
1-Student Loan Debt Forgiveness
The rising cost of education is putting too much burden on students and most can’t afford to pay the substantial loan amounts back. Such people can opt for debt forgiveness and try their luck. This strategy only applies to the loans given by the federal government so if you’ve taken up a private loan for your studies then chances are that your application will be rejected.
2-Public Service Loan Forgiveness
- The PSLF is another great option and this initiative is only for those who work for the government or an NGO. Here are the requirements that you’ll have to meet in this situation;
- You’ve paid at least the minimum amount due, every month. You qualify only if you’ve made your payments for at least 120 months.
- While making the payments, you’ve worked full time for qualified employees like a state, local or federal government agency.
3-Medical Debt Forgiveness
It’s a fact that medical expenses can grow a lot faster and this can ultimately lead to an overwhelming amount of debt. In such a situation, a medical debt forgiveness program can really come in handy. You first need to talk to your medical facility that’s the root cause of your debt and ask for any assistance policy like a charity care. Most NGOs have charity care and can reduce your debt or completely write it off depending on your situation.
- Your income is the first thing they will check to ensure that you can’t pay the loan back. If you really are facing financial hardship then you’ll most likely qualify for the program.
- The hospital will consider your insurance first. If your insurance doesn’t cover all your medical costs in case of a catastrophic medical event then yes, they might forgive your debt.
- Debt forgiveness might apply to a debtor who has absolutely no source of income to afford any repayments.
Understanding Debt Settlement
Debt settlement as the name implies is all about settling your debt with your creditor. This is more common when you’ve taken up a private loan and you don’t really qualify for debt forgiveness. In this strategy, a certain percentage of your loan is written off but you still have to pay the rest in order to be marked as “debt-free”.
How To Qualify For Debt Settlement?
The entire idea of convincing your creditor to forgive a part of your debt seems very intimidating but if you meet the criteria well and play strategically, chances are that your creditor will agree to your terms. Here are a few tips that can come in handy to you;
1-Stopping The Payments
In order to initiate a negotiation, a debt settlement company would recommend you to stop making the payments. This can have a negative impact on your credit score but that’s how you really convince your lender that you can’t afford the repayments.
2-Build A Settlement Fund
In debt settlement, you still need to have a significant amount saved to pay your creditor to become debt-free. Now, when you stop making the payments to the creditor at least 5 months before applying for settlement, you start putting that amount in a separate account as a settlement fund.
3-Negotiation Phase
The negotiation phase can make or break your deal. You need to have the funds ready and have an authentic reason that convinces your lender about your financial challenges. Bring proofs if you can and negotiate on a reduced settlement amount.
Key Points To Remember In Settlement Vs Forgiveness
Debt settlement and debt forgiveness are almost the same, the difference just lies in their eligibility criterias. Here are a few more key points you need to consider when choosing the right option;
It’s Negotiation Vs Cancellation
Debt settlement is where you negotiate with your creditor to reduce your debt amount whereas in debt forgiveness, your creditor will completely waive off the debt for you.
Tax Implications
In some cases, the settlement where your creditor forgives your debt can be considered taxable by the IRS. In other words, you might have to pay the tax on the forgiven debt.
Impact On Your Credit Score
Both debt settlement and debt forgiveness will have a negative impact on your credit score and it will stay on your report for 5 to 6 years. This usually happens due to the late or missed payments during the negotiation process.
Examples To Explain Debt Settlement Vs Debt Forgiveness
Debt Settlement: You owe an amount of $50,000 to your creditor and now when you can’t afford to pay the entire amount back, you talk to your creditor and negotiate on paying half of it, i.e, $25000 and get the rest of the amount written off.
Debt Forgiveness: You can’t afford to pay your student loan back so you opt for a government program that forgives student loan only to individuals who meet a specific income criteria.
The Final Word
If you have a significant outstanding amount of debt and due to various financial struggles, you can’t really meet the monthly repayments then you should opt for debt settlement or debt forgiveness as per your situation. To know which one is the right option, it’s better if you talk to a financial counselor or a professional who can tell you which criteria you meet and what option you should go for. If you have an authentic financial hardship, chances are that you’ll be accepted for a settlement. It’s just depends on the approach you use to negotiate with your creditor.
FAQs
Q1. What Is Full Settlement Of Debt?
In full and final debt settlement, your creditor agrees on receiving a lump sum amount from you instead of the full balance that you owe. In return, the creditor will write off the rest of the debt for you.
Q2.What Is The Downside Of Debt Forgiveness?
The one important drawback of debt forgiveness is that you could face tax consequences. If a creditor forgives a debt worth $600 or more, he has to report it to the IRS and that’s when you’ll receive a 1099-C tax form which means that you have to pay the tax on that amount which will cause unexpected and unwanted financial burden.
Q3. What Loans Are Not Eligible For Forgiveness?
You can only apply for debt forgiveness if you’ve taken a loan from the government or if it’s an unsecured loan that you can’t pay back. You are not eligible for debt forgiveness if it’s a secured loan with a collateral.
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