Debt cancellation – What is it, definition and concept

Debt cancellation consists of an operation through which a debtor and a creditor reach an agreement on an outstanding balance that is beneficial to both parties.

Therefore, we are not really dealing with a payment of the debt, but rather an agreement to cancel it. This may offer better payment conditions or total or partial forgiveness. As long as it benefits both parties.

Ways to perform debt cancellation

Debts can be canceled in various ways. In addition, this cancellation can be partial or total. Let’s see each one of them.

  • Anticipated cancelation. This usually occurs in bank loans. The borrower may decide, sometimes due to an improvement in his financial situation, to repay part of his debt or the entire loan. Normally, it carries a cancellation fee.
  • Debt subrogation. It usually occurs in mortgage loans. Thus, when we sell a flat with a mortgage, we can offer the buyer to take care of it. What is done is to discount it from the final price.
  • Agreement between the parties. In this case, it is a bilateral agreement in which both the debtor and the creditor decide how much the second pays and how it is going to be carried out.
  • Norms or laws. In various countries there are rules that regulate this process, sometimes painful. In Spain there is a so-called “Second Chance Law” that establishes debt cancellation procedures for entrepreneurs in trouble.

Debt cancellation. Requirements and recommendations

To cancel a debt, a series of requirements must be met by the debtor and it must be accepted by the creditor. Normally, this situation occurs when the person who must go through a moment in which it is impossible for him to pay.

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In mortgage debts and depending on the country, it is usually canceled by delivering the financed asset. However, in other circumstances, such as companies with financial problems or that could go bankrupt, a cancellation is proposed to them to avoid their closure.

On the other hand, there are some recommendations to avoid unnecessary expenses or situations such as those described. Above all, good financial planning, knowing what expenses and income I have and, therefore, how far I can go. It may seem obvious, but it is essential to do it.

Advantages and disadvantages of canceling debts

We are going to see some advantages and disadvantages of canceling debts. We are facing delicate economic situations in which we seek an option that benefits both parties.

  • The main advantage is a fresh start. When we cancel a debt, we remove that burden from our lives and we can start new projects.
  • On the other hand, a payment or amortization agreement will allow us to balance our budget of expenses and income. In turn, we will be able to deal with the debt without this implying our economic ruin.
  • The first drawback is the costs. The creditor had a payment plan with expected revenues in a given time. That way, when we cancel we have to make up for these benefits that you won’t get.
  • On the other hand, we have that, sometimes, the conditions imply increasing deadlines. Of course, if we do not have a clear plan, we will simply be delaying the problems.

Debt Cancellation Examples

Let’s see, finally, some examples of debt cancellation.

  • One of the most common, in countries like Spain, is the cancellation due to the Second Chance Law. This allows, in certain circumstances, the total or partial elimination of debts or an extension of terms.
  • Sale of mortgaged housing. For example, we sell a house that has a value of €100,000 and a mortgage of €40,000. The buyer takes care of it and either extends it for the rest, or pays the difference in cash. Normally, it entails certain surrogacy expenses.
  • A loan from a company with the bank. He decides, being a good customer, to give him a facility to pay him. He was five years old and it is extended to ten.
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