What Is a Charge-Off and How Does It Affect Your Credit?

A charge-off is a declaration by a creditor 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.

What Leads to a Charge-Off?

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:

30 Days Delinquent

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.

60 Days Delinquent

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.

90 Days Delinquent 

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, according to FDIC guidelines, meaning that the creditor realizes it may end up suffering some loss if the loan is not brought current.

120 Days Delinquent

Some loans that reach 120-day delinquency will be charged off. According to the FDIC, closed-end loans or installment loans, such as auto loans,  which are 120 days late, should be declared as a loss and a charge-off. Open-end loans, such as revolving credit card accounts do not fall under this 120-day rule.

180 Days Delinquent

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 as a loss and a charge-off.

How Does a Charge-Off Affect Your Credit? 

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 ends up with a collection agency after the 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.

Should You Pay Off a Charge-Off?

Even after an account is charged-off, you’re still responsible for 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 for credit or loans or asked to pay off your outstanding debts before you can be approved for a loan, such as a mortgage.

Paid-Off or Settled Charged-Off Accounts and Your Credit

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.

1. Pay off the charge-off via the original creditor

If the original creditor is still handling your debt after its charged-off, you can arrange to pay back the debt. Once the debt is paid off, the creditor will update the balance to zero and report that the status of the account is “paid charge-off.”

Lenders generally see a paid charge-off more favorably than a debt left unpaid.

2. Negotiate a settlement

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 as taxable income.

3. Pay off the collection

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.

4. Follow Up

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.

Most Recent Rules Affecting Charge-Offs

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:

  • Collection accounts are required to be updated on consumer credit reports once paid in full.
  • Collection accounts that are the result of unpaid debts not related to a contract or payment agreement, such as traffic tickets, are required to be deleted.

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.

Advantages of Monitoring Your Credit

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?

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