How Do Creditors Forgive Debt?

When a debtor owes a creditor money, the creditor will often choose to collect only partial payment of the debt, or none at all. This is known as "forgiving" or "writing off" debt. Although, generally, collectors will attempt to collect full payment of the debt, sometimes writing off debt makes greater financial sense. When a creditor forgives debt, he will usually undertake a number of actions involving both the debtor and credit reporting agencies.

Debt Collection

Before a creditor will forgive debt, he will generally attempt to first pursue payment. A creditor may choose to do this himself or he may outsource the task to a credit collection agency. Tactics employed in the collection of a debt may include sending the debtor phone calls or letters or more severe tactics, such as freezing the debtor's bank account or garnishing his wages. However, sometimes these measures may be prohibitively expensive.

Debt Forgiveness

If a creditor determines that collection methods are too expensive or that the debtor is only capable of paying off some of the money owed, he may choose to forgive the debtor all or part of the debt. The forgiveness may be offered outright by the creditor or it may come about through a negotiation with the debtor. When a debt is forgiven, it means that the debtor is no longer legally obligated to pay it.

Types

Debt forgiveness can come in various forms. In some cases, the debt may be forgiven in a contract. This is known as an Individual Voluntary Agreement. After an Individual Voluntary Agreement has been signed, the creditor can no longer pursue payment of the forgiven amount. Other times, debt will be forgiven as part of a debt settlement agreement, in which the debtor agrees to repay part of the debt, often under new terms, such as at a lower interest rate or over a longer period of time.

Credit Reporting

After a creditor forgives debt, he will usually choose to report this action to a credit reporting agency. The credit reporting agency will then mark the debt as being written off. Having a debt written off will negatively affect the debtor's credit score. To preserve the debtor's credit rating, some settlements between creditors and debtors will require that the creditor report the debt to the credit reporting agency as having been paid in full.