A charge-off is a creditor's declaration that a debt is unlikely to be paid. This happens when a consumer becomes severely delinquent on their payments – typically six months or more behind.
Charge-offs are reported to the credit bureaus and can damage your credit score. Even if a debt is considered a charge-off, you are still on the hook for the amount you owe.
As long as you make the minimum payments due on your account, you won’t have to worry about a charge-off. If you fall behind on your obligations, however, you run the risk of having the bank charge off your account — especially if you go without paying for an extended period.
Here’s an example of a timeline that leads to a charge-off:
When you fall 30 days behind on payments, your creditor or lender will usually send you a late notice, which may include late fees. Creditors may also increase your interest on future purchases.
If your creditor increases the interest on future purchases, that doesn’t mean the interest will remain that way indefinitely. You may be eligible for an interest reduction in the future with good payment history.
Under the Credit Card Accountability Responsibility and Disclosure Act of 2009, creditors are required to review your credit card account once every six months after it has raised your rate to determine if your account is eligible for an interest rate decrease. However, your creditors only have to review your account, not lower the rate, which means you could be stuck paying higher interest until you pay off your balance.
If you miss another month’s payment, making your payment 60 days late, your creditor will likely send another late notice. Additional late fees will also apply.
Your creditor may also increase the interest rate on your current balance. Not all credit card issuers implement a penalty APR. You can find out by looking at your credit card’s terms and conditions.
Each month you don’t make payments to bring your account current, you can expect to continue to receive late notices and incur additional late fees. Loans that reach this stage of delinquency are classified as substandard by creditors under FDIC guidelines, meaning the creditor recognizes it may incur a loss if the loan is not brought current.
Some loans that reach 120 days of delinquency will be charged off. According to the FDIC, closed-end or installment loans, such as auto loans, that are 120 days past due should be declared a loss and charged off. Open-end loans, such as revolving credit card accounts, are not subject to this 120-day rule.
Credit cards that are 180 days delinquent are subject to charge-off. According to the FDIC, after 180 days — or six months — of a consumer being delinquent on an open-end or revolving credit account, the creditor should declare the account a loss and charge it off.
Because accounts are typically charged off after 180 days, you will have already missed multiple payments before the charge-off. As you miss payments, your creditor will likely report the information to one or more credit bureaus, which will be noted in your credit files. Because payment history makes up a significant portion of your credit score, missed payments may have a negative effect.
If you continue not to make payments and your account is listed as a charge-off, your credit scores will likely suffer additional dings. If your account is sent to a collection agency after a charge-off, it will be noted in your credit history, which is a derogatory mark on your credit.
Even though a charge-off can remain on your credit report for seven years from the date it was first reported, the effects of the charge-off on your credit score can begin to lessen over time if you practice good credit habits, such as making on-time payments and paying off credit balances.
Even after an account is charged off, you’re still responsible for the debt until it’s paid off, settled, discharged as a result of a bankruptcy filing, or removed as a result of a validated dispute.
If you choose to pay the charged-off debt, it will be noted as such on your credit report. Anyone who pulls your credit report in the future will see the notation and know that you made the effort to repay your debt, which can reflect favorably on you.
If you choose not to pay off your debt, however, you may be denied credit or loans or asked to pay off your outstanding debts before you can be approved for a loan, such as a mortgage.
Charged-off accounts that you choose to pay off, or settle for less than the amount owed, can affect your credit score. Here’s how each situation is noted on your credit report.
If the original creditor is still handling your debt after it is charged off, you can arrange to pay it back. Once the debt is paid off, the creditor will update the balance to zero and report the account status as “paid charge-off.”
Lenders generally view a paid charge-off more favorably than an unpaid debt.
Sometimes, a collection agency or the original creditor will offer to settle the debt for an amount less than you owe. Many unsecured creditors will settle for 30 to 50 percent of the total debt owed. For example, if the balance you owe is $5,000 and the collection agency settles for 40 percent of the total debt, you’ll only have to pay $2,000.
Settling a debt may impact your credit score, but once you settle, there won’t be any more collection attempts. The debt will appear on your credit report as a “settled charge-off.” Be aware, however, that the IRS requires lenders to notify it whenever a debt of $600 or more is forgiven. If this happens, you could end up owing more taxes. According to the IRS, forgiven debt is considered taxable income.
If the original creditor has sold the charge-off to a collection agency, you can pay off the debt via the collection agency. You may want to write to the collection agency and ask it to verify that it owns the account before paying, so your payment will be credited properly.
After paying off a collection debt, your credit report will state, “paid collection,” which may appear more favorable to lenders than an unpaid debt.
After you’ve settled or paid the debt, ask the original creditor or collection agency to send you a confirmation letter. Follow up by checking your credit reports to ensure that the accounts are shown as paid or settled. If your credit report is not updated, you can file a dispute with the credit reporting agencies and use the letter as evidence to support your claim.
In June 2017, the National Consumer Assistance Plan, introduced by the three credit reporting agencies — Equifax, Experian, and TransUnion — to address errors on consumer credit reports, implemented new rules about collection accounts, including:
In addition, delinquent medical bill payments may not show up on your credit history until they are six months past-due. This grace period allows time for any insurance or billing issues to be sorted out.
After six months, if the payment is not resolved, medical collections could become part of your credit report. However, some credit scoring models do not weigh medical collections as heavily as other types of collections and may not factor them in at all if you choose to pay off the collection.
Like any other form of data reporting, the information that ends up on your credit reports could be inaccurate. In fact, 1 in 5 consumers has an error on their credit reports that can affect their scores. And even if it is accurate now, it can still be helpful to know when a change to your credit report occurs so you can verify it’s not a mistake or fraud.
If you don’t already have a product for monitoring your credit, you might want to consider ScoreSense. With it, you’ll get copies of all three of your credit reports, plus your credit scores. In addition, you’ll receive credit alerts if a threat is detected. Are you ready to start keeping a close watch on your credit?