What You Need to Know – TFFH – The Financial Freedom Hub

Credit card debt forgiveness, or debt settlement, involves negotiating with creditors to reduce the amount owed on your credit card balances. While it can help relieve overwhelming debt, potential consequences include damage to your credit score, tax implications, and potential legal actions from creditors. 

By the end of 2024, American consumers had more than $1.2 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. 

Learning more about credit card debt forgiveness will help you better identify ways to improve your finances and get your debt under control. Here’s what you need to know about this option for managing your finances.

Table of contents:

What Is Debt Forgiveness?

Debt forgiveness is a type of debt relief that involves a lender reducing or eliminating the amount you owe. For example, a credit card company may agree to forgive $400 of a $1,000 balance. 

Credit card debt forgiveness helps to simplify financial management, as it wipes away some of your debt, leaving you with more money for debt repayment or household expenses.

Debt forgiveness has the following potential benefits:

• Save hundreds or even thousands of dollars in interest, depending on how much you owe and how long it takes to pay the account in full.
• 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.

When Is It Time for Credit Card Debt Relief?

Dealing with high levels of debt can be stressful and may make even the most well-thought-out budget hard to stick to. Paying off credit card debt on your own can help you better manage your finances in the long run, but pursuing debt relief may be a better choice if you feel overwhelmed. 

You may want to consider debt relief if: 

• You’re struggling to make minimum payments
• You’re facing collection calls and/or legal action
• Your debt-to-income ratio is high (half or more of your income)
• You wouldn’t be able to pay off the debt within five years, even with strict budgeting

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 debt 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. Request a copy of your debt settlement agreement. 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 without severely hurting your credit.

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. They recommend this because some creditors are more willing to negotiate if you’re already several months behind. However, 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’re looking to preserve your good credit scores, but if you’re already behind on your credit cards, there’s no additional penalty for signing up.

File for Bankruptcy

Filing for bankruptcy can help you get a fresh financial start and may help you get rid of some or all of your debt. However, there are several pros and cons to consider:

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 bankruptcy 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, which lasts three to five years. Once you complete the payment plan, any remaining debts are discharged.

If you’re feeling unsure, an experienced bankruptcy attorney can further explain the differences between Chapter 7 and Chapter 13 bankruptcy and help you choose the right method for your situation. 

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 the forgiven debt.

Alternatives to Debt Forgiveness

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

Debt Consolidation

Credit card 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 debt consolidation loan for $8,000 with a single, predictable monthly payment.

Budgeting

If you don’t have much debt, creating a budget 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.

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.

Home Equity Lines of Credit

Home equity lines of credit (HELOCs) let you borrow against the equity in your home. You’re able to access your equity and borrow up to the maximum approved on the line of credit. If you pay down what you borrow, you can use the line of credit again, much like a credit card, until the draw period ends.

Avoid Debt Relief Scams

Unfortunately, some companies and scammers will prey on people who are overwhelmed by debt. To avoid falling victim, keep an eye out for these red flags when choosing a company for debt relief: 

• Upfront fees: Reputable companies won’t ask you to pay a fee before they’ve successfully settled your debt.
• Too-good-to-be-true promises: Be wary of companies that promise to wipe out all of your debt or boost your credit score overnight. 
• Pressure to sign up: Untrustworthy companies may rush you to sign up immediately without giving you time to ask questions and do your research before making a decision.
• Lack of transparency: A legitimate debt relief company will be upfront about its fees, services, and success rate. 

Take the First Step to Tackle Credit Card Debt

Taking care of your credit card debt can be stressful. But by catching up on payments or exploring different debt relief options, you may be able to get your finances back on track and start setting new financial goals.

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.

Checking your report regularly can help you keep track of your progress and make the most informed decisions as you pay off debt.