Should I Pay Off a Charged-Off Credit Card?
Facing charged-off credit card debt? Get clear insights into its impact and informed guidance on whether and how to resolve it.
A charged-off credit card account means the issuer has deemed the debt uncollectible and written it off as a loss, typically after 120 to 180 days of non-payment. While this is an accounting adjustment for the creditor, it does not erase the borrower’s obligation to repay the debt.
What a Charged-Off Account Means
This negative event appears prominently on a consumer’s credit report, often with a specific status code indicating a “charge-off.” The account may be reported by the original creditor, and if the debt is subsequently sold, a separate entry from a collection agency or debt buyer might also appear. A charge-off significantly harms credit scores, potentially causing a drop of 50 to 150 points or more, as payment history accounts for a substantial portion of credit scoring models like FICO. This derogatory mark remains on credit reports for up to seven years from the date of the first missed payment that led to the charge-off.
Implications of Unpaid Charged-Off Debt
Original creditors or third-party collection agencies will engage in ongoing collection efforts, which may include frequent phone calls, letters, and emails. The debt may also be sold multiple times to different collection agencies, each attempting to collect the balance.
A more severe consequence involves the possibility of legal action. If a lawsuit is filed and a judgment is obtained, the creditor may pursue various legal remedies to recover the debt. These actions can include wage garnishment, where a portion of earnings is withheld, or bank levies, which allow funds to be seized from bank accounts. Property liens might also be placed on assets, depending on state laws.
While a statute of limitations exists, limiting the time a creditor or collector has to sue for debt, this period varies by state, generally ranging from three to ten years for credit card debt. Even if the statute of limitations has passed, the debt itself does not disappear, and collectors may still attempt to collect it outside of court. An unpaid charged-off account continues to adversely affect creditworthiness, making it challenging to secure new loans, lines of credit, housing, or certain employment opportunities.
Deciding to Address Charged-Off Debt
When considering a charged-off debt, individuals have two primary resolution options: paying the debt in full or negotiating a settlement for a reduced amount. Paying off the entire balance typically results in the account status being updated to “paid” on the credit report, which is viewed more favorably by lenders than an “unpaid” status. However, the original negative mark of the charge-off will still remain on the credit report for up to seven years from the date of the initial delinquency.
Settling the debt for less than the full amount will usually result in the credit report showing the account as “settled for less than the full amount” or “paid collection.” While this improves the credit report status compared to an unpaid charge-off, it still indicates that the original terms were not met. Resolution can help rebuild credit over time, but it does not immediately remove the negative historical entry.
A financial consideration when negotiating a settlement is the potential for tax implications. If a portion of the debt is forgiven, the forgiven amount may be considered taxable income by the Internal Revenue Service (IRS). Creditors are generally required to issue Form 1099-C, Cancellation of Debt, to both the debtor and the IRS if the forgiven amount is $600 or more. This means that the amount of debt relief could increase an individual’s taxable income, potentially leading to an unexpected tax liability.
Steps for Resolving Charged-Off Debt
The initial step to address a charged-off debt involves identifying its current owner. The debt may still be held by the original creditor or sold to a third-party collection agency. Reviewing credit reports is a good starting point, as they should list the current creditor or collection agency.
Once the current owner is identified, send a written request for debt validation, preferably via certified mail with a return receipt. This request, ideally sent within 30 days of initial contact, asks the collector to provide proof of debt ownership, the original creditor, the amount owed, and a breakdown of charges. This step ensures the debt is legitimate and accurate before any payment or negotiation begins.
When negotiating a settlement, offer a lump sum payment if feasible, as collectors are often more willing to accept a reduced amount for immediate payment. Any agreement reached, including the settled amount and terms, must be obtained in writing before making any payment.
While some consumers inquire about a “pay-for-delete” arrangement, where the negative credit entry is removed for payment, credit bureaus generally discourage this practice, and collection agencies are not obligated to agree to it. After payment, retain all documentation, including the written settlement agreement and proof of payment, for future reference. Regularly monitoring credit reports after resolution helps ensure the account status is accurately updated to reflect the payment or settlement.