In tough economic times or during temporary financial hardship, it can be difficult to meet every financial obligation. However, not paying your debts can have severe negative effects on your credit rating and can hamper your ability to qualify for additional credit in the future. Debt forgiveness, reductions and deferrals are ways that your bank or lending institution may be willing to work with you when it comes to helping you meet your debt obligations without suffering undue financial hardship.
Debt Forgiveness
When a debt is "forgiven" by a creditor, you no longer have to pay it. In essence, the debt is wiped clean. You may find a forgiven debt listed as "paid in full" on your credit report, but for an amount that is less than the original agreement. It may also be listed as "settled." Regardless of how it's listed, having a forgiven debt is less damaging to your credit report than having a history of missed payments.
Debt forgiveness is most often an option when you've already paid off most of the debt and circumstances are preventing you from being able to make the final few payments. While it may be an attractive option if your creditor is willing, you should be cautious if the amount is too large. Forgiven debt is most often reported on your taxes as income. For larger amounts, this could push you into a higher tax bracket and result in increased tax liability.
Debt Reduction
Depending upon the amount you owe, you may be able to negotiate a debt reduction agreement with your lender. Debt reduction will lower the total amount you owe, while still allowing you to pay back some or most of the remaining debt. Your creditor may also adjust your payments to reflect the new, lower balance, or your payments may remain the same, allowing you to repay the debt faster.
Just as with debt forgiveness, the amount of the reduction may be taxable as income. However, if the debt reduction is due to a buy-off that eliminates interest payments, that amount is generally not taxable.
Debt Deferrals
If you are in the midst of a temporary financial hardship, such as a layoff or temporary disability, you may be able to negotiate debt deferral. For most types of deferrals, you will be required to either provide proof of your current income or sign a form stating that you are currently not receiving any income in order to qualify. Additionally, debt deferrals are usually for a short period of time, anywhere from a few months up to a year, after which you would need to reapply in order to continue having the debt deferred.
Unlike forgiveness and reductions, debt that is deferred will not be counted as taxable income. However, debt that has been deferred may continue to accrue interest, thus raising the amount you'll need to pay in the long term.
Benefits
The major benefit to debt forgiveness, reduction or deferral is the ability to maintain your credit rating. Another key benefit is the ability to avoid collection activity on unpaid debt. If you come to an agreement with your creditors before missed payments become a problem, you can avoid most of the collection calls, notices and other attempts by the creditor to obtain payment.
Considerations
Not all lenders will be willing to forgive or reduce a debt, but most will be willing to accept a deferral or adjustment in payment terms. You should do your research before you ask for any type of debt forgiveness or reduction, as the amount you save could be less due to tax considerations on the forgiven debt.
If you request a debt deferral, be certain to keep accurate records. If your creditor reports your payments as late to the credit bureaus, you'll need the deferment agreement to straighten out the error. Overall, even if you aren't currently paying on a debt, you still need to keep track of it for both record-keeping and tax purposes.
Debt forgiveness, reductions and deferrals are all potential options for remaining solvent and up-to-date on your debt payments. Speak with your creditors in order to take advantage of the type of debt relief that is best suited to your situation.
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