What is a Charge-Off? When Lenders Deem Debt Uncollectable, Borrowers Are Still on the Hook

When businesses or lenders consider a debt uncollectible, usually due to missed or nonpayment, they can charge the account off. When they do, the debt is no longer on their books.

The debtor still owes the money, though, and may have to pay a third-party collector which purchased the account. Here, I’ll cover everything you need to know about charge-offs, and how to avoid them.

When you borrow money from a financial institution, it will report your account activity to the consumer credit bureaus — TransUnion, Equifax, and Experian. If you miss a full payment cycle, it will show up as a 30-day late payment on your credit report. Continue to miss payments and a 60-day late, 90-day late, and so on, will be reported.

During that time, the lender will send warning notifications that your account is seriously overdue, and tell you what you can do to get back on track. If the account remains delinquent, eventually, the creditor will let you know that it will charge the debt off, which is usually 120 to 180 days after your first missed payment.

Businesses that are not lenders, such as utility companies and medical providers, rarely participate in the credit bureau system. If you owe them money for overdue bills, they may charge the debt off after a certain time-frame. It will show up on your credit report when they sell the account to a collection agency.

There are many reasons people have charge-offs on their credit files, including:

• Overspending on a credit card, then being unable to repay the minimum amount due
• Falling behind on loan payments because of financial hardship
• Filing for bankruptcy, causing the accounts included to be charged off 
• Identity theft is when somebody borrowed money in your name, but you didn’t find out until the accounts went delinquent

Credit damage begins when the first late payment appears on your credit report. As time passes without payments being posted, the harm to your credit worsens.

When the lender or business (which can also be a collection agency) considers the debt to be uncollectible, it will change the status of the account to a charge-off, and it will appear on your credit report as such.

Anyone who pulls your report will see the late payments and the charge-off associated with that account, and can make a judgment about your credit and financial health. Because charge-offs are a clear sign that you fell behind and did not fulfill your financial obligation to the creditor, it acts as a serious red flag to other lenders.

Credit scores, such as FICO Scores and VantageScores, are also impacted by charge-offs. These credit scoring models input all the credit information that appears on a credit file into a mathematical algorithm that predicts risk.

Although these credit scoring companies have developed different risk-based models, payment history is the most important credit scoring factor for both. For this reason, evidence that you did not pay as agreed will take your scores down considerably.

Long-Term Consequences

As long as a charge-off appears on your credit report, a lender is free to make a negative determination about your creditworthiness. Some financial institutions will not work with borrowers who have a charge-off on their file because it indicates too much risk.

Mortgages, especially, can be difficult to obtain when you have a charge-off on your credit report. The good news is that the most severe credit scoring damage will occur in the first couple of years after the charge-off is listed, but can be mitigated faster with positive credit use.

Reporting Period for Charge-Offs

Charge-offs will remain on your credit report for seven years from when the account first went delinquent. During that time, the charge-off and any late payments that preceded it will be factored into your credit scores.

Be aware that some businesses do not furnish information to all or even any of the credit bureaus. And if the debt bounces around from one collection agency to the next, you may find that some agencies report to one or two bureaus while others none.

It is important to note that the time frame does not restart with each new collector. The amount of time the debt can remain on your credit report is always seven years. If it shows up after that, contact the credit bureau and file a dispute.

When a business charges off a debt, it is writing the account off as a loss. After that, it can choose to sell the account to a third-party collector for less than the amount owed. This way it will not experience a total loss.

For example, if you owe $5,000, the collector may buy the debt for $2,000. The collector, which now owns the account, will usually attempt to collect on the total amount due.

In most cases, the collection agency will report that it owns the account, so you will see that company’s name on your credit file. Their acquisition will not erase the past, though, so you will still see the stream of late payments and charge-offs from the original creditor, as well as the collection agency that now owns it.

If the account does go to collections, you will probably receive messages, letters, and calls from the agency about the debt. While they often state they want all of the money immediately, it may be possible to negotiate a settlement and even pay in a few installments.

When you do not pay a debt or bill as agreed, another issue you may face is legal action. A creditor may decide to file a lawsuit against you. Most creditors will give you ample warning that the situation has deteriorated, and if you don’t pay up, they will sue you in court.

Take these warnings seriously. Respond to all the paperwork and get legal counsel if necessary. Make sure you show up in court, too. If you don’t, you will not have the opportunity to defend yourself.

You may lose by default, and a judgment will be filed against you. In some cases, the creditor will be allowed to collect the money via wage garnishments (a portion of your pay will be sent to the judgment creditor), liens on property (making property titles unclear), or even levies (the forced sale of assets and property).

Although these types of judgments can no longer be listed on credit reports and can’t affect your credit scores, they are a matter of public record. If a lender conducts a search and finds a judgment, you may be denied credit.

Because charge-offs can be so problematic, take all steps necessary to ensure that you make debt payments on time:

Set up automated payments: Almost all banking systems allow you to set up bill pay, where money is automatically sent from your checking account  to your creditors. You can also do it through your lender or credit card company. It can take the guesswork out of your money management but also monitor your accounts so you know everything is posted as it should.

Budget to prioritize debt payments: You definitely want to ensure that there is enough money in your budget to cover your loan and credit card payments. On a regular basis, analyze your cash flow and make any necessary adjustments. Remember, credit products can help you pay for things, not act as a substitute for income you don’t have.

Become and stay organized: If disorganization is causing you to forget about bills, create a system that works for you. Have one designated spot in your home for letters from your creditors so they never get lost in a shuffle. Set alerts that go to your email or messaging service for upcoming bills, or use money management apps to keep you on track.

Review your credit reports to spot fraud: If someone has opened an account in your name, then used the money and didn’t make the payments, it can end up as a charge-off without you even knowing. You can visit annualcreditreport.com to pull your reports weekly and check thoroughly. If you do notice fraud, you can dispute it with the credit bureaus and have it removed from your report.

Communicate with Card Issuers

If you suspect that you cannot make your payments as agreed and you have no other feasible way to get the money, contact your creditors immediately and ask for assistance. It is always best not to wait until your account is delinquent because the longer you wait, the less apt they may be to give you a break.

Depending on the circumstances, you may be able to arrange a hardship program where you send less than the minimum payment or even defer payments completely for a specific number of months. This will keep your account in good standing.

Just be sure not to make a promise you can’t fulfill. Be conservative. If you don’t know for certain that you will resume normal payments in three months, ask for a longer time period. 

Use Credit Counseling Services

Nonprofit credit counseling agencies can be extremely helpful when you are financially stressed. Counseling is often free, and a professional will go through your budget with you to help you refine spending, provide important resources, and give you the support you need to make good decisions about your debt.

If you have enough money left over after paying essential bills to meet your credit card payments, you may enroll in their debt payment program. You would make one payment to the agency, which would then distribute the funds among your creditors.

The creditors would receive the payments on time, offsetting the possibility of delinquencies and charge-offs. This program is arranged to get you out of debt in three to five years. Many creditors have agreed to lower the interest rate for people who participate, too, so it could be less expensive than if you were to pay on your own.

In the event you cannot avoid a charge-off, take action to rebuild your credit soon afterward. Although it is not possible to remove accurate and timely information from your credit report, you can add positive information to your file that can offset the damage.

Make all payments on time: For any existing accounts that appear on your credit file, send every payment before the bill is due. The longer the stream of on-time payments, the more the charge-off will fade into the background.

Prove you can use credit wisely: Keep balances to a minimum and only use credit cards to charge things that you can afford, and then pay the balance in full. You will be showing creditors that you can borrow and repay responsibly.

Open new credit accounts: If you do not have any active credit accounts, consider opening a secured credit card designed for people who have damaged credit. Or you could apply for a credit builder loan where you make payments before getting the money. The key is to add excellent information to your credit file that will offset your preceding problems.

Make personal finance management a priority: Keeping track of how much money you have, owe, and need is essential. Conduct a daily or weekly review so you do not come up short.

Save for emergencies: Setting even a little money aside every month to build up a savings account that you can tap into is a financially healthy habit. This way, if a problem does arise, you will be able to handle it with cash on hand.

When it comes to personal finance, mistakes are almost inevitable. There may come a point when you spend too much and struggle to pay your credit card debt off, or even miss a loan payment.

Just get back on track as quickly as possible. This way, you can avoid a charge-off and all the associated troubles that come with it.