Do You Have to Pay a Charged Off Credit Card?
Charged-off credit card debt remains an obligation. Understand its impact on your finances and explore effective ways to address it.
A “charged off” credit card debt is an internal accounting adjustment by the original creditor. It means the lender recognizes the debt as unlikely to be collected and removes it from active accounts for financial reporting. A charge-off does not forgive or eliminate the consumer’s obligation to pay the debt. The debt remains a legal liability for the borrower, despite being a loss for the lender. This classification has significant implications for the individual who owes the money.
What “Charged Off” Means for Your Debt
When a credit card debt is “charged off,” the original creditor writes it off as an uncollectible loss. This typically occurs after about 180 days of missed payments. For the creditor, this removes the debt from their balance sheet as a bad debt expense for accounting and tax purposes.
Despite being charged off, the debt is not erased or forgiven. The consumer remains legally obligated to repay the full amount. The creditor may continue collection efforts or sell the debt to a third-party debt buyer for a fraction of its value. The legal obligation to pay persists, regardless of the creditor’s internal accounting decision.
Impact on Your Financial Standing
A charged-off debt significantly damages financial health, primarily affecting credit scores and reports. It is a severe negative mark, signaling to potential lenders that the borrower defaulted. This can lead to a substantial drop in credit scores, typically by 50 to 150 points, making it difficult to obtain new credit.
A charged-off account remains on credit reports for up to seven years from the original delinquency date, continuously impacting creditworthiness. This long-term presence can hinder approval for loans for homes or vehicles, and may affect interest rates. It might also influence other areas, such as increasing insurance premiums or impacting certain employment background checks.
How Creditors Pursue Charged-Off Debt
After a debt is charged off, creditors or debt buyers employ various methods to recover the balance. The original creditor might continue collection efforts or assign the account to a collection agency. Often, original creditors sell the debt to third-party debt buyers for a small percentage of the amount owed. These buyers acquire the right to collect the full debt, plus interest or fees.
Collection tactics involve phone calls, letters, and emails. If unsuccessful, the creditor or debt buyer may file a lawsuit to obtain a judgment. A court judgment can lead to wage garnishment, bank levies, or property liens.
A time limit, called a “statute of limitations,” exists for creditors or debt buyers to legally sue to collect a debt. This period varies by state and determines how long a creditor has to initiate a lawsuit from the date of the last account activity. Even if the statute of limitations has passed, debt collectors may still attempt non-legal collection, as the debt itself is not extinguished. Understanding these timeframes provides a defense against a lawsuit, but does not eliminate the debt.
Strategies for Addressing Charged-Off Debt
Addressing charged-off debt requires a proactive approach. One option is to pay the debt in full, which updates its status to “paid” and can improve credit standing over time, though it doesn’t immediately remove the charge-off from a credit report. Paying the full amount demonstrates financial responsibility to future lenders.
Negotiating a settlement for less than the full amount is another common strategy, particularly with debt buyers. When negotiating, offer a lump-sum payment, typically 25% to 50% of the original balance. Get any settlement agreement, including the agreed-upon amount and terms, in writing before making any payment. “Pay-for-delete” agreements are rare and often not honored by original creditors.
Payment plans can also be arranged, allowing the debtor to pay off the settled amount or the full balance over time. This can be a more manageable option than a lump sum, though it may extend the collection process. For individuals facing overwhelming debt, including charged-off accounts, bankruptcy might be a consideration as a last resort. Bankruptcy can discharge eligible debts, providing a fresh start, but has significant and long-lasting credit impacts.
Tax Considerations for Forgiven Debt
When a creditor settles a charged-off debt for less than the original balance, the forgiven portion may be considered taxable income by the IRS. If the canceled debt is $600 or more, the creditor or collection agency generally issues Form 1099-C, “Cancellation of Debt,” to both the debtor and the IRS, reporting the forgiven amount.
Individuals who receive a Form 1099-C must report this amount as ordinary income on their federal tax return. However, certain exceptions or exclusions may allow an individual to avoid paying taxes on the canceled debt. A common exclusion is insolvency, where total liabilities exceed total assets at the time the debt was canceled. If an exclusion applies, taxpayers file Form 982, “Reduction of Tax Attributes Due to Discharge of Indebtedness,” with their tax return to claim it.