Do I Still Owe a Canceled Debt?
Having a debt canceled or forgiven by a lender can ease your financial worries. Some people owe more than they can afford to pay. Bankruptcy is an effective solution to this problem. But because a bankruptcy remains on a credit report for 10 years and drastically lowers scores, some debtors consider other alternatives for dealing with high balances.
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What is Debt Cancelation?
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Debt cancelation occurs when a lender or creditor willingly agrees to forgive a percentage of a debt. However, it's not common for lenders to remove a financial obligation. If you sign a loan agreement or credit card agreement, you accept responsibility for a debt and agree to repay this money. But if you fall upon financial hardship and can't pay your balances, a lender or creditor may agree to cancel a portion of your debt.
Examples of Debt Cancelation
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Several situations justify debt cancelation. A borrower may request a short sale or deed in lieu of foreclosure to escape mortgage foreclosure. A lender might agree to reduce the outstanding balance with a short sale or cancel a debt and take ownership of a property with a deed in lieu. Additionally, a borrower may negotiate a debt settlement to satisfy his outstanding credit card and loan balances for less than he owes. The creditor or lender may consent to the settlement, and then cancel the remaining balance.
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Owing Debt after Cancelation
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Borrowers do not owe the creditor or lender once a balance is forgiven through debt cancelation. With this arrangement, creditors and lenders consent to taking a loss. Borrowers can still protect themselves by acquiring written confirmation of any debt cancelation or settlement agreement made with a lender. For example, if a creditor agrees to settle a credit card debt for $3,000 less than the balance owed, a debtor should request a letter as proof of this agreement, and only send his payment once he receives confirmation.
Taxes and Forgiven Debt
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Debt cancelation or forgiveness can increase your tax bill. The Mortgage Debt Relief Act of 2007 benefits borrowers who had their mortgage debt canceled with a foreclosure, short sale or deed in lieu. These individuals are not subject to tax consequences through 2012. But if a creditor or another type of lender forgives or cancels a percentage of your debt by means of a settlement, the canceled amount is considered income and is subject to income tax. For example, if a creditor cancels a $5,000 debt balance, you could pay taxes on this $5,000.
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