How Does a Charge-Off Work and What Happens Next?

A charge-off occurs when a creditor, such as a bank or credit card company, determines that an outstanding debt is unlikely to be collected. This accounting action reclassifies the debt on the creditor’s books from an active asset to a loss. While a charge-off indicates the creditor has ceased internal collection efforts, it does not erase the borrower’s obligation to repay the debt.

Understanding a Charge-Off

From a lender’s perspective, a charge-off is an internal accounting adjustment that writes off a debt as a loss. This typically happens after a prolonged period of non-payment, signifying that the creditor no longer expects to recover the funds through their regular collection processes. Lenders perform charge-offs for various reasons, including regulatory requirements and to accurately reflect the value of their assets on financial statements. Federal regulations, for instance, often require revolving credit accounts, like credit cards, to be charged off after 180 days of non-payment. Installment loans may be charged off after 120 days of delinquency.

The timeline involves several stages of delinquency. After a missed payment, an account becomes 30 days past due, then progresses to 60, 90, and 120 days. If payments are not made for approximately 180 consecutive days, the account is deemed uncollectible and charged off.

Immediate Consequences of a Charge-Off

Once a debt is charged off, its appearance on a credit report can have a severe and immediate negative impact on an individual’s credit score. The entry will typically be labeled as “charge-off,” “bad debt,” or “written off,” signaling to other potential lenders that the debt was not repaid as agreed. Since payment history is a significant factor in credit scoring models, a charge-off can cause a substantial drop in a credit score, potentially by 50 to 150 points.

A charged-off account remains on a consumer’s credit report for up to seven years from the date of original delinquency. This negative mark can make it challenging to obtain new credit, such as loans or credit cards, and may even affect approval for housing or insurance.

Navigating the Aftermath

After a debt is charged off, the original creditor usually ceases internal collection efforts. The debt is frequently sold to a third-party debt buyer or assigned to a collection agency, often for a fraction of its original value. These agencies then assume the right to pursue payment from the borrower, using various communication strategies like phone calls and letters. While the debt may now be handled by a new entity, the original charge-off entry from the initial creditor typically remains on the credit report. Even when the debt is sold, the borrower’s legal obligation to repay remains.

A creditor may issue a Form 1099-C, Cancellation of Debt, to both the borrower and the Internal Revenue Service (IRS). This form is typically sent when a debt of $600 or more is canceled, forgiven, or discharged. The amount may be considered taxable income by the IRS, meaning the borrower could owe taxes. Exclusions, such as insolvency, may apply, which could reduce or eliminate the taxable portion. Consulting with a tax professional is advisable to understand specific tax implications.

Individuals have several options to address a charged-off debt. Paying the full amount owed updates the credit report entry to “paid charge-off,” which is viewed more favorably by prospective creditors than an unpaid charge-off, though the negative mark remains for up to seven years. Another option is to negotiate a settlement for less than the full balance; if successful, the credit report may show “paid charge-off for less than the full balance,” and this could also lead to a Form 1099-C for the forgiven portion. Consumers can also dispute inaccurate information related to a charge-off on their credit report with credit bureaus, which will investigate the claim.