6 credit card debt forgiveness risks to know

In today's economy, many people find themselves struggling with expensive credit card debt. With credit card interest rates averaging about 23% currently, any credit card balance you carry can quickly balloon out of control, leaving you looking for solutions to alleviate the burden that comes with rapidly compounding credit card debt. While there are numerous solutions to consider, credit card debt forgiveness, also known as debt settlement, is one option that can seem particularly appealing. 

When you pursue debt forgiveness, the goal is to reduce the total amount you owe on your credit cards by negotiating with your creditors, allowing you to pay off your balances for less than the original amount. In some cases, this type of debt relief could even cut your balances by 30% to 50% or more, providing major relief from your high-rate credit card debt.

The promise of settling a large amount of debt for pennies on the dollar can seem like the perfect solution, and it certainly can be, especially if you're on the brink of bankruptcy. However, these programs are not always as simple as they may appear, and the process of negotiating debt forgiveness can be fraught with complications. So before pursuing this option, it's crucial to understand what the potential risks are.

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6 risks of pursuing credit card debt forgiveness

The risks that can come with debt forgiveness include the following:

It may not result in owing less

One of the biggest risks of pursuing credit card debt forgiveness is that there is no guarantee that your creditors will agree to settle for less than the full amount owed. Creditors are under no obligation to negotiate or forgive any portion of your debt. If they reject the settlement offer, you may still owe the full balance, plus any late fees and interest that have accumulated during the negotiation process. 

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It could cause long-term damage to your credit

Debt forgiveness programs almost always come with a significant impact on your credit score. When you stop making payments to your creditors while the settlement process is ongoing, your accounts will become delinquent, which will be reported to credit bureaus. Delinquent accounts and settled accounts (where the creditor agreed to accept less than the full amount) can stay on your credit report for up to seven years. This will significantly lower your credit score, making it difficult to qualify for loans, credit cards or even housing, until your score improves. 

The interest and fees could accumulate

During the debt settlement process, you will typically be advised to stop making payments to your creditors, which can lead to the accumulation of fees, penalties and interest. That means your unpaid balance can grow substantially due to late fees and high interest rates before the settlement negotiations even begin. If a settlement is not reached, you could end up owing far more than you initially did due to these charges, which can create an even more overwhelming financial situation than you started with.

It could result in legal action

Another risk of pursuing credit card debt forgiveness is the potential for legal action. If your creditors are unable to forgive a portion of your debt or are unwilling to negotiate, they may decide to sue you for the unpaid balance. A court judgment in favor of your creditors could lead to wage garnishment, bank account levies or liens on your property. Legal proceedings can also increase the overall cost of your debt and further harm your financial standing.

There could be tax consequences

Many people are unaware that forgiven debt is often considered taxable income by the IRS. If a creditor forgives $600 or more of your debt, they are required to report this amount to the IRS and you will likely receive a 1099-C tax form. This means that you may have to pay taxes on the forgiven amount, which can create an unexpected financial burden. While some may qualify for insolvency exemptions, that's not always the case.

There may be other costs, too

Debt relief companies charge fees for their services, which can vary, but will typically range between 15% to 25% of the total enrolled debt. These fees may be worth it depending on the outcome of the negotiations, but can still eat into any savings you might achieve through the forgiveness process. 

The bottom line

While credit card debt forgiveness might seem like an attractive option for those overwhelmed by debt, it is important to weigh the risks carefully. There is no guarantee of success, and the long-term consequences — ranging from damage to your credit score to potential legal action — can be severe. So while you may find that debt forgiveness makes the most sense for your situation, you should still consider all of your debt relief options before making a decision. Being informed and cautious can help you avoid unintended financial pitfalls.