If I Pay a Charge-Off, Will It Help My Credit?

The question of whether paying a charged-off account improves credit is common for many individuals navigating financial challenges. Credit scores are complex, influenced by various factors that collectively paint a picture of an individual’s financial responsibility. Understanding how different actions, including resolving past debts, affect these scores is important for managing one’s financial health.

What is a Charge-Off

A charge-off occurs when a creditor determines that a debt is unlikely to be collected. This happens after an account has been delinquent for a significant period, often between 120 to 180 days of missed payments. The lender writes off the debt. Despite being written off, the debt is not forgiven; the borrower remains legally obligated to repay the amount.

Once charged off, the account is reported to the major credit bureaus (Experian, Equifax, and TransUnion) as a negative mark. This adverse entry on a credit report indicates a severe delinquency. The immediate impact on a credit score is significant, as payment history is the most influential factor in credit scoring models. A charge-off can cause a substantial drop in credit scores, making it difficult to obtain new credit or favorable terms.

How Paying a Charge-Off Impacts Credit

Paying a charge-off has a positive impact on your credit, though it does not remove the negative entry from your credit report. When you resolve the debt, its status on your credit report changes from “charged-off” to “paid charge-off” or “settled,” depending on how it was resolved. Changing the status indicates that the debt has been addressed. This resolution is viewed more favorably by credit scoring models like FICO and VantageScore.

The improvement in credit scores from paying a charge-off is modest and occurs gradually over time. It signals responsible financial behavior and reduces the overall amount owed, which can positively influence the “amounts owed” portion of your credit score. The age of the charge-off also plays a role, with older paid charge-offs having less impact than recent ones. Resolving the debt is a step toward rebuilding a positive credit profile.

Different Ways to Pay a Charge-Off

There are two primary methods for resolving a charged-off account: paying the full amount owed or settling the debt for a lesser amount. When you pay the debt in full, the account status on your credit report will be updated to “paid in full.” This indicates that you fulfilled the original terms of the agreement, which is viewed most favorably by lenders and credit scoring models. Paying in full can help your credit score recover more quickly over time.

Alternatively, you can negotiate with the creditor or collection agency to settle the debt for less than the full outstanding balance. If a settlement is reached and paid, the account status will be updated to “settled for less than full amount” or “settled.” While settling is not as advantageous for your credit score as paying in full, it is still significantly better than leaving the debt unpaid. Settling a debt can also prevent further collection efforts or potential legal action.

It is important to be aware that if a debt is settled for less than the full amount, the forgiven portion may be considered taxable income by the Internal Revenue Service (IRS). Creditors are required to issue a Form 1099-C, Cancellation of Debt, if the forgiven amount is $600 or more. Consulting a tax professional is advisable to understand the specific tax implications based on individual circumstances.

How Long Charge-Offs Affect Your Credit

A charge-off remains on your credit report for a specific period, seven years from the date of the original delinquency. This seven-year timeframe begins from the first missed payment that led to the charge-off, not the date the account was actually charged off. This means the negative entry will continue to appear on your credit report even if you pay or settle the debt.

Paying or settling a charged-off account does not remove it from your credit report before this seven-year period expires. It only changes the status of the account to reflect that it has been resolved. Over time, the negative impact of a charge-off on your credit score diminishes, especially as the entry ages.

Improving Your Credit Beyond Charge-Offs

Beyond addressing charged-off accounts, several other factors influence credit scores and contribute to overall credit health. Payment history, whether bills are paid on time, is the most influential factor in credit scoring models, accounting for approximately 35% of a FICO Score. Consistently making on-time payments on all accounts is important for maintaining a strong credit profile.

Credit utilization, the amount of revolving credit used compared to the total available credit, is another significant factor, making up about 30% of a FICO Score. Keeping credit card balances low, below 30% of the credit limit, can positively impact scores. The length of credit history also plays a role, contributing around 15% to a FICO Score. A longer history of responsible credit use is more favorable.

The types of credit used (credit mix) and recent applications for new credit also influence scores. While credit mix accounts for about 10% of a FICO Score, demonstrating the ability to manage different types of credit responsibly can be beneficial. New credit inquiries can cause a small, temporary dip in scores, so it is advisable to apply for new credit only when necessary. Regularly checking credit reports for accuracy and promptly disputing any errors are also important practices for maintaining good credit.