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What Is Cancellation Of Debt?

What Is Cancellation Of Debt?

Cancellation of debt or debt cancellation, as it is sometimes referred to as, happens when a creditor relieves the borrower from any debt obligations they may have. Debtors in this instance are able to directly negotiate with a creditor for debt forgiveness. A debtor can also get their debts cancelled by filling for bankruptcy or via a debt relief program. 

You should note that debts forgiven by a creditor are still considered taxable income. Cancelled debt has to be reported to the IRS by the creditor and debtor on a 1099-C form.

How Does Cancellation of Debt Work?

Debt can be cancelled in various ways, including debt relief programs, personal bankruptcy, and negotiations between the debtor and creditor. This section provides a more detailed look into each debt cancellation process.


In certain instances, bankruptcy might be the best or only option for a borrower. There are various forms of bankruptcy with Chapter 13 and Chapter 7 being the most common variants for individuals. Chapter 7 bankruptcy requires you selling off or liquidating your assets to pay your creditors, even if partially. Chapter 13 might enable you to keep some assets, however, you must agree to a payment plan with your creditors under court supervision. Bankruptcy, regardless of the type, can have long-term negative consequences for an individual. Hence, it is something that shouldn’t be entered lightly. For instance, a Chapter 7 bankruptcy can remain on your credit report for up to 10 years, while a Chapter 13 can remain for up to 7 years.

Debt Relief Programs

Reputable debt relief and settlement companies can help with debt forgiveness.  The National Foundation for Credit Counselling and other credit counselling resources can help a borrower identify a program that fits their particular situation. 

Debt settlement companies can also be for-profit organisations that work on behalf of the borrower to negotiate with the creditors. When choosing this process, you need to ensure that you are dealing with a reputable entity. You should also be aware that the process of debt settlement can take years. Nevertheless, debt settlement can be a great option for borrowers who have no hope of catching up on their payments. 

The process works by debt settlement entities assessing a borrower’s credit profile before contacting creditors directly on behalf of the borrower for debt forgiveness. These debt relief programs typically request that the borrower stop making payments on their monthly credit bills to increase the probability that their creditor settles. Typically, most companies might also require their clients to make monthly escrow payments that would be used as a lump sum settlement in the future.


Negotiating a debt cancellation with a creditor can be quite difficult since creditors, understandably, want to get the money they are due. Nevertheless, a creditor might be willing to cancel a percentage of the debt if the rest is paid. This process works on the assumption that getting some money back is better than getting nothing at all. Some creditors already consider this possibility before lending, so they place provisions in their credit agreements for cancelled debt.

Numerous creditors also have credit relief programs available to debtors for an additional fee, and these typically come into play during hardship situations such as serious illness or job loss. Certain loans, particularly those issues under government programs can have a higher probability of debt forgiveness. These loans include mortgage loans, and federal student loans under government-sponsored relief programs. In the instance of mortgages, some lenders might be willing to consider principal reductions since it can be less expensive than initiating a foreclosure.



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