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How does debt forgiveness work?

Debt forgiveness can allow you to clear your debt by paying less than you owe. It does not erase the full debt or leave you without consequences.

U.S. News and World Report explains that many people misunderstand what debt forgiveness is and think it works like bankruptcy, but it does not. Typically used for credit card debt, forgiveness allows you to make an agreement with the lender to pay only a portion of the amount you owe with the company forgiving the remaining unpaid portion. While this sounds similar to bankruptcy, there are two issues that may come with debt forgiveness that do not occur with bankruptcy.

The expense

The biggest issue you may run into with debt forgiveness is taxation of the amount forgiven. The government sees this as a gift or income because it is money you got and did not have to pay back. The creditor may send you a tax form if the amount is over $600. The IRS will determine if you owe taxes and how much you owe by looking at how much you owed and the amount the creditor forgave.

The impact

Debt forgiveness will also have an impact on your credit. Since you were behind on payments when you got the debt forgiveness, it shows on your credit as a bad mark. This will remain on your credit report even if you make a forgiveness agreement. This is where forgiveness differs greatly from bankruptcy. With bankruptcy, you have all the delinquencies removed from your credit reports, but debt forgiveness does not offer this same benefit.

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