Should I Pay Off a Closed Credit Card Account?
Understand the implications of outstanding debt on closed credit cards. Explore strategies to manage these balances and improve your financial standing.
A credit card account that is no longer active but still carries an outstanding balance can present a confusing financial situation. Many individuals find themselves unsure of the implications or the best course of action. This article explores the various considerations for dealing with closed credit card accounts that still have an outstanding balance, shedding light on their financial implications.
Understanding Closed Credit Card Accounts
A closed credit card account refers to an account where new purchases can no longer be made, but any existing balance remains a financial obligation. This differs from simply paying off a card and keeping it open. The account’s “closed” status does not eliminate the responsibility to repay the outstanding debt.
Credit card accounts can become closed for several reasons, initiated by either the cardholder or the issuer. A cardholder might request closure to simplify their finances or reduce the temptation to incur more debt. Conversely, a credit card issuer may close an account due to prolonged inactivity, a history of late payments, or other breaches of the cardholder agreement.
The Unpaid Balance on Your Credit Report
An outstanding balance on a closed credit card account impacts a consumer’s credit report, primarily affecting credit utilization. This ratio compares your total outstanding balances to your total available credit. Lenders prefer this ratio below 30%, as lower percentages often lead to higher credit scores.
When an account closes with a balance, its credit limit is removed from your total available credit. This can sharply increase your credit utilization ratio, potentially lowering credit scores. Missed payments on any account, including closed ones, also significantly affect payment history, which accounts for approximately 35% of a FICO Score. A single payment 30 days past due can remain on a credit report for up to seven years from the delinquency date.
An unpaid balance on a closed account continues to accrue interest and late fees. Credit card annual percentage rates (APRs) can range from an average of 20% to 25%, with penalty APRs reaching up to 40%. Late fees, which averaged around $32 per missed payment, also add to the debt burden.
If the debt remains unpaid, the original creditor may eventually “charge off” the account after about 180 days of non-payment. The debt may then be sold to a third-party debt collector, who will report the collection account to credit bureaus. Both charge-offs and collection accounts can remain on a credit report for up to seven years from the original delinquency date.
Improving Your Credit After Paying Off a Closed Account
Paying off a closed credit card account with an outstanding balance can improve your credit report and scores. When the balance reaches zero, this is reported to credit bureaus. A zero balance significantly lowers your credit utilization ratio, a major factor in credit scoring.
Even though the account remains “closed,” removing the balance positively influences credit scores. Accounts closed in good standing stay on reports for up to 10 years, contributing to credit history length. Paying off debt, even with prior negative marks like late payments or charge-offs, is noted. While negative history typically remains for seven years, a “paid” status on a collection or charge-off is viewed more favorably by lenders, and some newer scoring models may ignore paid collections. This demonstrates responsible financial behavior, helping rebuild your credit profile.
Options for Addressing the Outstanding Debt
Addressing outstanding debt on a closed credit card account involves practical steps. First, verify the debt, especially if it’s with a debt collector. The Fair Debt Collection Practices Act (FDCPA) allows consumers to request written validation of a debt within 30 days of initial communication. This validation confirms the amount owed and identifies the current creditor.
The most straightforward option is to pay the entire outstanding balance, which immediately resolves the debt and improves credit by eliminating interest and fees. If full payment isn’t feasible, establish a structured payment plan with the creditor or collector to pay off the debt over time through regular installments.
Debt settlement is another option, where you negotiate to pay a reduced lump sum. While this reduces the amount owed, it may be noted on your credit report as “settled for less than the full amount.” There are also tax implications: if $600 or more of debt is forgiven, the creditor may issue an IRS Form 1099-C. This forgiven amount may be considered taxable income by the IRS, unless exceptions like insolvency apply. In cases of insolvency, you might exclude the forgiven debt from income by filing IRS Form 982.