What Happens When Accounts Are Charged Off As Bad Debt?

A charge-off is one of the worst black marks on your credit report and can cause your credit score to plummet my more than 100 points.

But what causes a charge-off, what does it mean and is it even possible to reverse the credit score damage?

Key Points

• A charge-off means a lender has written off your debt as uncollectible.
• You still legally owe the charged-off debt.
• A charge off can knock your credit score down by more than 100 points.
• If you want to negotiate settlements to repay less than the full amount that you owe, you will have to wait until the debts have been charged off.

Why Debts Are Charged Off

If you stop making payments on your loan or credit card account for several consecutive months, your creditor will assume that it is not getting its money back, and will write off the loan as “bad debt.”

Pro tip: This means the lender has given up all hope that you’ll ever repay the money you owe.

Your account will be closed, and a notation will appear on your credit report.

Many types of debt are charged off as bad debt. These include:

• Personal loan debt
• Credit card debt
• Student loan debt
• Revolving lines of credit
• Any other unsecured debt you’ve failed to repay

Pro tip: Charge-offs should not catch you by surprise. If you have outstanding debt, you will get multiple late payment notices, calls from your lender and maybe even be contacted by a debt collector before the account is officially charged off.

When the creditor decides to charge off your debt, the three major credit reporting agencies (Equifax, Experian and TransUnion) will be notified. The debt may also be sold to a debt collection agency or a debt buyer or turned over to an in-house collections department.

At this point, expect the calls reminding you to pay your debt to become more aggressive. Though federal laws limit debt collectors’ actions, many will try to harass you, contact your friends and family and even threaten legal action to get you to pay them.

Pro tip: Even though the creditor has written off the debt, you legally still owe the money.

Charged-Off Debt and Debt Settlement

If you’re enrolled in a debt settlement program, you must understand the role charge-offs play in the process.

Debt settlement involves contacting the lender and offering to pay less than the total amount you owe. In exchange, the lender considers the debt paid off.

When you first commit to debt settlement, you will be asked to stop making your monthly payments and wait for them to be charged off.

READ MORE: Debt settlement pros and cons

It may sound counterintuitive to sit back and wait for the black marks to hit your credit report — but don’t focus on the short-term impact. As you advance through the settlement program and start making settlement payments, the charge-off notations will be replaced with notations that your debt has been repaid through a settlement agreement and your credit score will rebound.

Pro tip: If you have a significant amount of unsecured debt ($7,500 or higher), debt settlement offers an excellent alternative to take control of your finances and become debt free by paying less than the entire total you owe. Debt settlement customers save an average of 30% of the total amount they owe after paying the debt settlement company’s fees.

READ MORE: Best debt settlement companies

How Long Does It Take for a Debt to Be Charged Off?

A charge off won’t be immediate. Missing a single payment or two usually won’t trigger one. It usually takes a timetable ranging from 120 to 180 days without a payment (four to six months) for a lender to charge off your debt.

You will still owe the money. Unless you contact your lender and arrange a settlement or file for bankruptcy, you will remain responsible for repaying the debt until the statute of limitations on debt in your state is reached.

Payment history makes up 35% of your FICO score, so your credit score will fall significantly once the debt is charged off. Charge-offs mean you’ve established a long-term pattern of missed payments.

Pro tip: FICO is one of the two major credit-scoring models. The other is VantageScore.

If you already have bad credit, the damage will be less severe than it will be for borrowers with fair or good credit scores. That’s because you’re starting at a lower spot, and your credit score will not fall below 300.

READ MORE: Why did my credit score drop?

Maintaining a good credit score is essential. A low credit score means:

• Higher rates for car loans
• Higher interest rates for personal loans
• Difficulty obtaining new credit cards
• Risk of denial for new credit cards
• Getting a cell phone will be tougher
• Landlords may deny your rental application — even if you pay a security deposit
• Fewer employment opportunities

READ MORE: How to get a free credit score

How Long Will a Charge Off Stay On Your Credit Report?

If you don’t pay or settle the charged-off account, the charge-off notation will remain on your credit report for seven years after your first missed payment. The date will not reset if the account is sold to a collection agency.

Pro tip: A paid or settled notation will help your credit score because even though it will be a blemish on your credit history, it shows that you’ve made an effort to fulfill your legal obligation to repay your loan.

READ MORE: What credit score do you start with?

If you don’t pay the debt, it will automatically fall off your credit report in seven years. You should not need to take any additional steps to remove it unless there’s a glitch and it remains on your credit report several months after the deadline.

READ MORE: How to remove a charge off from your credit report

For your negotiations to be successful, you must complete a few steps before contacting your creditor. This includes:

• Build a savings account
• Figure out how much of a lump-sum settlement you can afford to pay
• Determine when you can make the payment

If one settlement payment is impossible, try to negotiate a payment plan. Just be aware that the charge off won’t be removed from your credit report until you’ve made all of the payments

Once you’re prepared to make a settlement offer:

Contact your creditor

Make sure you’re speaking with someone with the authority to negotiate. Tell the creditor how much you can afford to pay and explain that you are able to make a payment immediately, but in exchange, you’d like the charge off to be removed from your credit report and the debt to be considered paid in full.

Get It In Writing

If you reach an agreement, make sure the creditor sends you written confirmation of the agreement, noting all of the specifics.

Make Your Payment

As soon as you have written confirmation of the agreement, submit payment. Be sure to keep proof that you’ve paid.

Pro tip: Either send a payment via certified mail to prove the creditor received your payment, or, if paying electronically, keep screenshots and bank statements in case you have to prove that you submitted a payment.

Get Documentation That Your Debt Has Been Paid

Get written confirmation of the paid charge off, so you can submit it to the credit bureaus if the entry isn’t updated to reflect your payment promptly.

Pro tip: If a creditor refuses to agree to a “pay-for-delete” agreement but offers you a settlement you can afford, it is in your best interest to consider accepting that offer. Updating the account status to “settled” will help your credit score significantly.

What To Do If You Find a Charge Off You Don’t Recognize

Whenever you find an item on your credit report you don’t recognize, you must immediately verify that the entry is legitimate. You may have been a victim of identity theft. If so, you must freeze your credit immediately to limit the damage.

READ MORE: How to check your credit reports

After that, contact the lender or creditor who says you owe the money.

Ask for Debt Validation

Federal law requires that debt collectors and creditors must verify all unpaid debts in writing.

Pro tip: This is called a debt validation letter. When a lender or debt collector contacts you, they must send the letter within five days of the initial contact about the debt. You should always ask for one, even if you know the debt is legitimately yours.

The letter will include:

• How much you owe
• Your original lender
• Instructions on how to contest the debt
• If the debt collector fails to respond, it could give you grounds to dispute the charge off.
• After you receive a debt validation letter, figure out:
• Is this debt legitimately yours?
• Has the lender or debt collector failed to record payments you’ve made?
• Is the debt near or past your state’s statute of limitations on debt?

Follow Up With a Request for Debt Verification

Credit bureaus make mistakes, and it’s more common than you might think. The charge off could be a clerical error or be due to a misrecorded payment.

If you believe there’s an error, you should dispute the error and ask the creditor to validate your debt.

The terminology can be confusing, so remember that:

• The collection agency sends a debt validation letter to provide information about the debt the collector claims you owe.
• A debt verification letter requires the creditor to prove that you owe the debt. If the debt collector fails to prove that the debt is legitimately yours, you will likely be able to remove the debt from your credit report — even if you know you owe the money.

You can request verification of old debts on your own. You don’t need to pay a credit repair agency to do this.

If you aren’t sure what to say, copy and paste this simple template into a document and fill in your relevant details:

Debt Verification Letter Template

Date
Account Number

I am sending this letter in response to [a letter/phone call] on [date you received the letter/call] regarding an unpaid debt of [$] owed to [creditor]. Please provide verification of this debt.

Please respond with a letter including the following information:

• Name and address of the original creditor
• Account number
• Total amount owed
• Evidence supporting the claim that I am required to pay the amount owed
• The age and amount of the debt
• Whether this date is within the statute of limitations
• A copy of the latest billing statement from the original creditor
• A breakdown of interest or payments made since the last billing statement
• Legal authorization for those interest charges
• The date the original creditor says the debt became delinquent
• Proof of your authority to collect this debt
• Proof that you are licensed in my state, including the name, license number, date the license was issued
• The name, address and phone number of the agency that issued the license

If you are based in a different state, please also provide licensing information from your state.

Name

Pro tip: Send the letter by certified mail to your creditor or credit card company and include delivery confirmation. If you cannot print your letter, your local library will generally have printing services for a small fee.

To learn more about charge offs, check out this video:

Other Debt Relief Options

Contact your original creditor or credit card issuer before the debt is sold to a third-party collector or charged off. They may be willing to work with you or offer special programs if you’re experiencing short-term financial hardship.

• Try debt consolidation: Use a new loan to repay your existing loans. You can use a debt consolidation loan, personal loan or even a home equity loan. As long as the new loan has a lower interest rate, consolidation will help you tackle debt issues.
• Talk to a debt settlement company: A reputable company will help you negotiate a settlement agreement and make sure you make your payments. They know which creditors will be willing to settle and can usually get you the best results.
• Debt Management Plan: With a DMP, a credit counselor will contact your creditors and set up a repayment plan for your unpaid debts. Instead of paying a lump-sum fee as you would with a debt settlement company, a DMP will have a monthly fee ranging from $25 to $75.

READ MORE: Debt settlement vs. debt management

If You’re In Trouble, Act Quickly

Debt doesn’t just magically disappear. Take swift action as soon as you notice you’re struggling. Contact a debt settlement company or a nonprofit credit counseling agency — or call your creditor directly to ask about hardship programs.

READ MORE: Got $50,000 in debt? Here’s how to pay it off fast

The Bottom Line

The easiest way to deal with charged-off debt is to avoid it in the first place. Try to stay on top of your finances, examine your free credit reports each year and monitor your credit accounts to ensure you’re keeping up with your minimum payments.

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