Debt forgiveness takes place when a lender writes off some or all of a balance due from a borrower. A creditor may forgive the debt of either an individual or business debtor. Banks sometimes choose to forgive a portion of your debt as part of a restructured loan deal to help you pay off the remainder.
To forgive a debt, a lender essentially removes the amount due from its books. In accounting, amounts a company is owed are recorded as "accounts receivable." As the debt is paid, the receivable balance lowers, and cash and revenue rise. If you owe $10,000 on a debt, and the lender forgives $3,000, it has to reduce its accounts receivable by $3,000. To do so, it writes off the $3,000 as "bad debt." This move reduces the lender's net profit, reducing its tax obligation.
Despite the potential tax advantage of writing off uncollected debt, lenders don't normally succeed in business by routinely forgiving debt. When an offer of forgiveness is made, it is normally because the lender feels it is in its best interest to do so. If you owe more than you can afford to pay on a debt, the lender may decide it is better to forgive a portion of the amount owed to enable you to make reasonable monthly payments. Over time, the lender gets more if you pay back a significant portion of the debt than none at all. The lender prefers that you avert default or bankruptcy in most cases.
Some mortgage lenders may include debt forgiveness as part of a mortgage restructuring. Assuming no better option exists, the lender may offer to reduce your mortgage balance with a write-off to leave you with a manageable monthly payment. In business, a lender may decide it is in its best interest to forgive a fraction of a business loan so that your company can keep up with payments on that loan as well as others.
What Is Not Forgiveness
Some debt maneuvers don't qualify as debt forgiveness. USLegal.com says consolidating or deferring loans aren't examples of debt forgiveness. With consolidation, you simply get a large loan that pays off your higher rate accounts and credit cards, thus reducing your creditors and monthly payments. A deferral means you delay payments due for a specified period of time, though the balance remains the same.
Neil Kokemuller has been an active business, finance and education writer and content media website developer since 2007. He has been a college marketing professor since 2004. Kokemuller has additional professional experience in marketing, retail and small business. He holds a Master of Business Administration from Iowa State University.