What is a Charge-Off?

Image of stressed couple looking at bills

We've all heard the term "charge-off". We know that it's bad and we know that we don't want one, but what exactly does it mean to have an account charge-off? Do we still have to pay a charged-off account or does the debt eventually "go away"? When exactly does an account charge-off?

What Exactly is a Charge-Off?

In the simplest of terms, when a creditor charges-off an account they are taking an account off of their accounting books that they assume will never get paid. They consider it a loss and remove it from their balance sheet so that it can't be carried on the books as an asset.

Creditors have a legal obligation to charge-off accounts when they are a certain number of days past-due, but the timeframe varies depending on the type of debt and whether or not you're on a workout plan to repay the debt. These plans can be either internal plans set up directly with the creditor, or external plans such as debt management plans (more on DMPs later). For example, credit card accounts that aren't on a repayment plan must be put into charge-off status if the account is 180 days past-due, while personal loans and credit card accounts that are on a workout plan will charge-off after 120 days of delinquency. Since the timeframe varies from account to account, it's best to ask your creditor what their specific guidelines are.

A large misconception is that once an account has charged off, you are no longer responsible for the debt. Not true. Creditors charge-off accounts for their benefit, not yours. Rest assured, the creditor still wants their money and they'll do what they must to get it. This could mean using internal collection tactics, selling the account to a bill collector with a collection agency, or the worst case scenario- bring you to court and get a judgment. A charge-off is one of the worst marks that you can have on your credit report because it's the highest stage of delinquency that an account can reach. Since charge-offs remain on your credit report (make sure you understand your credit report) for 7 years you'll want to avoid them at all costs

Why are Charge-Offs on the Rise?

Americans love their credit cards. Although credit card purchases have declined in recent years, economists predict that consumers' confidence in economic recovery will bolster increased credit card spending and increased credit card debt. Prior to the recession, Americans were spending without fear because they were employed and the economy was relatively strong. Once the economy started to spiral downward, unemployment soared as companies had to cut costs in order to keep their doors open. Foreclosures were commonplace. People were out of money; they were barely able to put food on the table and keep a roof over their heads. Consumers were forced to make difficult decisions about which bills they needed to pay for basic survival, and making credit card payments was at the bottom of their list. Frankly, when faced with a choice between buying food and making a minimum credit card payment, the latter just didn't seem all that important.

How to Avoid a Charge-Off

The only way to avoid a charge-off is by getting help before it's too late - before the account actually charges off. It may seem daunting, especially if you have multiple accounts that are past-due, but there are alternatives that could help you avoid charge-offs and get you back on track. One option is to learn more about credit counseling. These agencies are typically non-profit and are highly regulated by the states in which they operate. They specialize in these types of situations and they may be able to help you avoid further delinquency. A credit counselor will review your income and expenses and give you advice on how to improve your situation on your own if they are not able to enroll you into some sort of plan, so it's worth the call. They'll teach you the basics: how to create a household budget; how to identify ways to cut expenses; and how to save money. After they perform this review, which is usually free, they may determine that a debt management plan is the best course of action for your particular circumstances.

What is a Debt Management Plan?

Learn more about debt management plans, also referred to as DMPs. They were designed to help consumers consolidate their unsecured debts and get them paid off in a reasonable amount of time. The benefits that these plans can offer help consumers who are behind on their credit card payments. They can bring their accounts current and reduce their interest rates so that the payments are more affordable. Remember, it costs the creditors more money to pay a collection agency or to bring you to court, so they are often willing to work with credit counseling agencies and most will offer benefits that will help to ensure that they get their money.

When you opt to enroll in a DMP, the credit counseling agency will send proposals to each of your creditors. The proposals will list the balance, account number, contact information, and the proposed monthly payment. Most major creditors offer certain benefits for DMP clients and, in most cases, will offer interest rate reductions (sometimes lowering it to 0%) and some will even re-age past-due accounts to a current status. But, even if your particular creditors don't offer to re-age your accounts, a DMP will could reduce the amount of your minimum payment, making it more likely that you'll be able to make that payment every month for the life of the program. Additionally, these plans are set up so that your accounts will be paid in full within a 4-5 year timeframe, which could be decades less than the amount of time it would take you on your own, making just the minimum payments.

It's important to note that not everyone will qualify for a debt management plan, and not all creditors offer the same benefits. However, most of the major creditors offer some sort of assistance through these plans. Either way, if you find yourself falling behind on your payments, you must be proactive. Contact a credit counseling agency and speak to a counselor to find out how they may be able to help.

Rebuilding After a Charge-Off

If your accounts have been charged off, there's nothing else you can do except start rebuilding your credit. There are several ways that creditors report a charge-off depending on whether the debt is still outstanding (charged-off), has been settled (charged-off settled), or has been paid in full (charged-off paid). Remember, you are still liable for this debt. It hasn't vanished because it's charged off. Keep in mind, this will stay on your credit report for 7 years from the original delinquency date leading to the charge-off, so the best thing you can do is work hard to get it paid off.

Common Misconceptions

Many people believe that if an account is sold to a collection agency that the 7-year credit report period starts over. This is a tactic used by some collection agencies to scare people into making a payment. There's still only one debt in question and just because it was sold to a collection agency, it doesn't create a second debt, and therefore it can only be reported once. Granted, your credit report may be confusing because you may see the same debt listed multiple times. The original account should be updated to show that the account was "transferred/closed" and shouldn't show a balance. It's always a good idea to review your credit report at least once per year to be sure things are reported accurately.