The purpose of your credit score and your credit report is clear. Both are meant to indicate to potential lenders, landlords and other financial providers the likelihood that you will repay any credit they extend.
A prime indicator that you are not a good credit risk is a charge-off, a term that refers to an account that a creditor deems a lost cause.
“A charge-off means that your account was either written off as a loss by the company with whom you had credit, such as a credit card company, or that the account was sent to a collection agency for payment,” says John Danaher, president, consumer interactive of TransUnion credit reporting agency in Chicago.
When Charge-Offs Are Triggered
Depending on the type of account you have, your creditor will charge off your debt 120 or 180 days after you stop making payments.
“Creditors, especially credit card companies since they don’t have the option of repossessing your car, don’t like to do this,” says John Ulzheimer, an Atlanta-based credit expert, formerly with FICO and the credit bureau Equifax. “They would much rather you paid them than default.”
Creditors must follow rules when reporting a charge-off to credit reporting agencies.
Rod Griffin, director for consumer education and awareness for Experian credit bureau, based in Costa Mesa, California, says, “The Fair Credit Reporting Act has guidelines that require anyone referring an account for collections or a charge-off to report the date of the original delinquency within 90 days of when the account went to collections or was charged off.”
The delinquency date is the month and year that you first defaulted on repaying your debt. If the balance owed has been sold to a collection agency, the debt collector must also report that same delinquency date, since that determines when the negative item can be removed from your credit report.
“You won’t normally get a phone call or a letter about a charge-off,” says Ulzheimer. “You’ll either eventually see it on your credit report or you’ll hear from a third-party debt collector who bought the debt.”
Do You Still Owe Money on a Charge-Off?
While a charge-off means that your creditor has reported your debt as a loss, it doesn’t mean you’re off the hook.
“Whether purchasing clothing on a credit card or financing your home with a mortgage, you’ve entered into a legal agreement with a lender to pay back those debts,” says Danaher. “And that contractual obligation remains until the debt is paid or you’ve come to terms with that lender to pay back the debt at a lower amount. That obligation also remains even if it’s sold to a collection agency or even if it has been charged off for accounting purposes.”
[Read: The Best Credit Cards for Bad Credit of 2018.]
Generally, the balance you owe is sold to a third-party debt collection agency for “pennies on the dollar” because the creditor aggregates multiple delinquent debts and sells them as a package to get some return of its funds, says Ulzheimer. That debt collection agency will then begin contacting you for repayment and can continue to charge interest on the debt, which increases the balance. The fees and interest charged are regulated by federal and state laws and can be impacted by your original agreement with the creditor.
Some larger financial institutions have an internal debt collection agency, he says, which means your debt could be turned over to that department for continued collection efforts.
You can also be sued by a creditor after a charge-off up to a defined statute of limitations, which varies by state and by the type of debt. In most states, the statute of limitations for suing for an unpaid debt is three to six years.
How a Charge-Off Impacts Your Credit
A charge-off will stay on your credit report for seven years from the date of the delinquency, regardless of whether you subsequently repaid the debt, says Griffin.
“This allows lenders to distinguish consumers who always pay on time from those who pay late and from those who default and never pay at all,” says Danaher. “This allows lenders to offer the best terms to the lowest-risk consumers.”
Potential creditors look more favorably on someone with a charge-off marked “Paid” or “Paid in Full” rather than “Settled” or “Settled for Less than Owed,” since the two latter comments indicate that you did not repay the full balance of your debt, says Griffin.
“Under some of the latest credit scoring models from FICO and VantageScore, a charge-off marked ‘Paid’ or ‘Paid in Full’ is excluded from the calculation of your credit score,” says Griffin. “So, paying a charge-off or collection account may help you improve your credit score.”
Medical collections also weigh less heavily in your credit score calculation in newer scoring models whether or not they have been paid in full, says Griffin.
A charge-off just subtracts more from your already dropping credit score.
Typically, someone with a charge-off has seen their credit score fall because of the months of delinquent payments before the charge-off. A charge-off can have a cumulative negative impact on your credit because of the months of late or nonpayment notices followed by the charge-off and the debt collection report. “If you already have a low score, [a charge-off] will still drop your score but by fewer points,” says Ryan Greeley, Denver-based editor of the Better Credit Blog.
However, Greeley points out, the impact of a charge-off fades over time.
“A charge-off that happened a year or two ago is much worse than one that you dealt with six years ago,” says Greeley.
[Read: The Best Credit Cards for People With Fair Credit.]
New Rules About Reporting Charge-Offs
The National Consumer Assistance Plan, introduced by the three credit reporting bureaus to address errors and inaccuracies on consumer credit reports, implemented new rules about collection accounts in June 2017.
Among the changes were requirements for more detailed and accurate information, including updating when collection accounts have been paid in full. In addition, collections from creditors that didn’t arise from a contract or payment agreement were removed from credit reports. For example, collections from unpaid debts such as traffic tickets or parking fines were deleted from consumer credit reports.
How to Handle a Charge-Off Error
If you believe the charge-off on your credit report is a mistake, you can immediately initiate a dispute investigation online with the credit reporting agency. You should also notify the creditor that you are disputing the charge-off. You’ll need to gather documentation such as proof of payments or evidence of identity fraud to support your dispute.
“If the account isn’t yours, your payments were misapplied or you suspect fraud, then you need to challenge this with the creditor or go to all three credit bureaus,” says Ulzheimer. “It’s more efficient to go directly to the creditor, since they have to correct it with the credit bureaus.”
Steps to Negotiating a Charge-Off
If the charge-off is correct, you can sometimes negotiate a repayment plan. It’s rare to have a legitimate charge-off removed from your credit report, but it’s possible to request that during negotiations, says Ulzheimer.
“There’s nothing that requires a credit reporting agency to remove it even one day earlier than seven years, as long as it is correct,” Ulzheimer says. “It’s best to pay off the debt or settle it with the creditor for a lesser amount and then work to rehabilitate your credit with on-time payments on other accounts.”
If you can’t pay the balance in full, you can try to start negotiations with the creditor.
[Read: The Best Balance Transfer Credit Cards of 2018.]
Your first step, he says, is to determine who owns the debt.
“You can only negotiate with the current creditor, not the original bank or lender,” says Ulzheimer. “Debt collectors are legally not allowed to lie to you, so you can ask them if their company owns the debt or someone else owns it.”
Creditors want to talk to you if you let them know you want to discuss a debt settlement, says Ulzheimer.
Your ability to negotiate depends in part on how old the debt is, the size of the balance and whether the creditor thinks you have the means to pay.
“Debt collectors can pull your credit report and see if you have another way to pay, such as an open credit card account with an available balance,” says Ulzheimer.
If the debt is owned by a collection agency, that probably means the agency purchased it for a small percentage of the balance and may be willing to accept less money from you, he says. He suggests offering to pay 25 percent of a large balance as a starting point, recognizing that the agency will likely want you to pay much more. If the balance is small, such as $300, the agency is likely to require payment in full.
“You can try to negotiate a ‘pay for delete’ arrangement, which means your repayment is contingent on the removal of the charge-off from your credit report, but that happens very infrequently,” says Ulzheimer.
Any negotiation should be confirmed in writing. The creditor should clearly state that you don’t owe more money, that collection activity will cease and that your credit reports with all three agencies will be updated with a zero balance, says Ulzheimer.
Are There Tax Implications of a Negotiated Charge-Off?
If you successfully negotiate a settlement for less than the full amount of your debt, the remaining debt can be considered “forgiven,” which will trigger a tax implication, says Griffin. You will receive an IRS 1099-C form, which indicates that the forgiven debt is considered income, and will typically need to pay taxes on that income, with a few exceptions.
“Unless some of your debt is forgiven, there are no tax implications of a charge-off,” says Griffin.
Don’t Ignore a Charge-Off
A charge-off is a serious financial problem that can hurt your ability to qualify for new credit. While you may not be able to remove a legitimate charge-off from your credit report, finding a way to pay the debt partially or in full is an important step toward rehabilitating your credit.
“The biggest benefit of paying in full or settling a charge-off is that you won’t be sued for the debt and you stop accruing interest on the debt,” says Ulzheimer. “In addition, you should feel a sense of accomplishment that you closed the loop on that problem and that you will avoid repeating your mistake in the future.”
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Steps to Remove a Charge-Off From Your Credit Report originally appeared on usnews.com
