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Debt Forgiveness: How It Works

Are you concerned that you might not be able to pay off all your debt? You may be wondering if it’s possible to have any of your debt forgiven. Unfortunately, there are not many options for debt forgiveness. There are really only two ways that this can happen. The first way is through bankruptcy, and the second is through debt settlement. If these options don’t sound appealing to you, don’t worry! There are other ways to deal with your debt. American Consumer Credit Counseling is here to explain the different types of debt forgiveness and some better alternatives!

Debt forgiveness might not be your only option.

Debt forgiveness might not be your only option.

Debt Forgiveness Option 1: Bankruptcy      

“Bankruptcy” is one of those words that we hear a lot, but many people don’t really understand how it works or how it affects your financial life. So, what is bankruptcy? Bankruptcy is a proceeding in a federal court in which an insolvent debtor’s assets are liquidated and the debtor is relieved of further liability. In simpler terms, if you are unable to pay your debts, you must liquidate your assets (such as property, stocks, or bonds) in order to repay some of your unsecured debts. Then, your debt is “forgiven,” and in theory, you have a fresh start financially.

There are two types of bankruptcy: Chapter 7 and Chapter 13. Chapter 7 bankruptcy is a type of bankruptcy that is meant for people with low-incomes who cannot pay their debts. Instead, their property is sold to make up for it. Chapter 13 bankruptcy, on the other hand, involves a court-mandated repayment plan to pay off a portion of outstanding debt without selling any property. Chapter 13 bankruptcy will remain on your credit report for seven years, while Chapter 7 bankruptcy stays for ten years. Both types of bankruptcy can seriously damage credit scores.

Debt Forgiveness Option 2: Debt Settlement

Another form of debt forgiveness is known as debt settlement. Debt settlement companies allow consumers to pay them one monthly payment rather than paying all their creditors every month. This payment is lower than what they would be paying on their own. This is because debt settlement involves paying less than the principal amount of debt you owe. While it may sound like a good option because it looks like you’re saving money on the “forgiven” debt, think again. Because you aren’t paying off the entire amount of debt you owe, your credit score will suffer. Additionally, any money that you save from settling will be counted as income by the IRS, so you will have to pay taxes on that. Besides that, debt settlement companies often charge high fees, so in the end, you aren’t saving as much money as you might have though you would.

What other debt help is available?

Are there other types of debt relief available? Here are a few options:

  • Debt consolidation             
  • Debt management
  • Debt snowball method
  • Debt avalanche method

These forms of debt relief are NOT debt forgiveness, because with these methods, you pay off all the debt. If you choose one of these options and stick to it, your credit score will not be damaged, and may actually increase. The first two options are administered by financial institutions or credit counseling agencies, while the latter two can be done by yourself.

Debt consolidation programs are administered by financial institutions, and they are similar to debt settlement in that they also involve one monthly payment to the debt consolation company rather than to multiple creditors. Often with debt consolidation, you take out a loan to pay off your debt. As long as you are making your payments on time, this shouldn’t have a negative impact on your credit score. Of course, if you are late or miss payments, like with any other loan, it could hurt your score.

A debt management program is similar to debt consolidation, except there is no loan. It is administered by a credit counseling agency. First, you call the credit counseling agency and go through a  credit counseling session in which the counselor asks about your income, expenses, assets, and liabilities. From there, they can enroll you in a debt management program, and your monthly payment will be lower than what you would have paid your creditors. This is because the credit counseling agency negotiates lower interest rates and fees, but you still pay off the principal amount.

The debt avalanche and debt snowball methods are debt repayment methods you can do yourself! With the debt avalanche method, you start aggressively paying off the account with the highest interest. While you do this, you make the minimum payments on your other accounts. When you pay off the account with the highest interest, you move on to the account with the second highest interest. The debt snowball method works the same way, but starting with the account with the highest balance instead.

How do I choose the best option for me?

When it comes to paying off your debt, how do you decide between debt forgiveness and other debt relief options? Unfortunately, there’s no right answer. It depends on your individual financial  situation. As bad as the two debt forgiveness options may sound, given that they damage your credit score and report, sometimes they are your only option.

Of course, if you don’t have to go through debt settlement or bankruptcy, the other debt relief options may be good for you. If you have a stable income and are disciplined and organized, you may be able to pay off your debt without help from an outside agency. Conversely, if you feel overwhelmed, it can be helpful to get advice and talk to a credit counselor and enroll in a debt management program. What will you choose?

If you struggle to pay off debt, ACCC may be able to help. Sign up for a free credit counseling session with us today! 


Madison is a Marketing Communications & Programs Associate at ACCC. She is excited to share her tips on saving money and being financially responsible here on the Talking Cents blog!

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