BACK

Expert Q&A

What is a charge-off? How does it affect your credit?

Summary

The phrase charge-off comes from the world of financial accounting, but if one happens to you, expect the damage to your credit to be substantial

The editorial content below is based solely on the objective assessment of our writers and is not driven by advertising dollars. However, we may receive compensation when you click on links to products from our partners. Learn more about our advertising policy.

The content on this page is accurate as of the posting date; however, some of the offers mentioned may have expired. Please see the bank’s website for the most current version of card offers; and please review our list of best credit cards, or use our CardMatch™ tool to find cards matched to your needs.

Question for the CreditCards.com expert

Dear New Frugal You,
I often hear the phrase “charge-off” used in discussions about credit cards and credit scores. I don’t understand what it is. Could you help explain it and how it affects me? — Confused in Carolina

Answer for the CreditCards.com expertDear Confused,
The term can be a bit confusing if you’re not familiar with accounting or financial jargon.

A charge-off is an accounting entry. A bank or other lender considers your debt to be an asset. It’s an asset because it has value. But if you get behind in your payments, the value of that asset falls into question. And, after a while, the IRS requires the bank to remove your loan from its assets. The bank then “charges off” part or all of your loan from its books.

So a charge-off is an accounting activity. It also is a report that goes to the credit bureaus and gets incorporated into your credit score. If you have a loan marked as charged off, it will hurt your credit score. A charge-off will remain on your credit report for seven years.

What it is not is a release from your debt. Even if an account is charged off, you still owe the money. And, as it turns out, it may even make it more difficult to repay the debt afterward.

Charge-off aftermath
Here’s why. When a bank charges off a debt, it will typically do one of three things:

  1. Try to collect the debt itself.
  2. Hire a collection agency to collect for them.
  3. Sell the debt to a collection agency.

You have no control over when a debt is charged off. That’s determined by law and the lender. Even if you have every intention of repaying the loan, it may still be charged off. A credit card account is usually charged off when the customer fails to make minimum payments for 6 months.

As we mentioned, this action will hurt your credit score. Thirty-five percent of your score is based on your payment history. Any late payments will lower your score. So the charge-off hurts, but most of the damage has already been done by the late payments. The higher your score was to start with, the greater the damage will be.

Debts still worth paying
Once a debt is charged off, it will be tempting to not to pay it even if you have the money to do so. You may want to reconsider for two reasons.

First, by paying the debt, you can change the status of the account to “charged off, paid.” That tells other future lenders that you make every effort to repay, even if it’s hard to do so. That status looks much better to lenders than a status of just “charged off.”

Second, if you negotiate a debt settlement (paying less than you owe), you could find yourself owing taxes. Any time a lender forgives a debt of more than $600, it is required to notify the IRS and the forgiven debt is added to your taxable income for the year.

If that does happen, you may qualify for an exemption. The exemptions are fairly generous. See a qualified tax preparer to be sure.

I hope you’re not behind on any of your bills and the question about charge-offs is just because you’re confused. Yet, even if that’s the case you’ll still be affected by charge-offs.

The credit card companies estimate how much they’ll lose to charge-offs. And they charge everyone higher fees and interest rates to cover those losses. So everyone who uses a credit card will pay a little extra because of charge-offs.

For the next year or two, we’ll all continue to hear more about charge-offs. It’s an unfortunate side effect to a tough economy and the large amount of consumer debt outstanding.

See related: Repaying charged-off debt, Debt negotiation in three (not) easy stepsHow many points off? FICO reveals how common credit mistakes affect scores

What’s up next?

In Expert Q&A

Money Talks: Q&A with boxing champ Bernard Hopkins

Also an astute businessman, the light-heavyweight world champion just shakes his head at his peers’ foolishness with money

Published: August 18, 2011

See more stories
Credit Card Rate Report Updated: August 21st, 2019
Business
15.55%
Airline
17.49%
Cash Back
17.63%
Reward
17.49%
Student
17.69%

Questions or comments?

Contact us

Editorial corrections policies

Learn more

Join the Discussion

We encourage an active and insightful conversation among our users. Please help us keep our community civil and respectful. For your safety, do not disclose confidential or personal information such as bank account numbers or social security numbers. Anything you post may be disclosed, published, transmitted or reused.

The editorial content on CreditCards.com is not sponsored by any bank or credit card issuer. The journalists in the editorial department are separate from the company’s business operations. The comments posted below are not provided, reviewed or approved by any company mentioned in our editorial content. Additionally, any companies mentioned in the content do not assume responsibility to ensure that all posts and/or questions are answered.