Should You Pay a Charged Off Credit Card?

A charged-off credit card debt presents a financial challenge. When an account becomes severely delinquent, typically after several months of missed payments, the creditor classifies it as a “charge-off.” This accounting action means the creditor has written off the debt as a loss. This article provides information on charged-off credit card debt, its nature, impact, and resolution strategies.

Understanding Charged-Off Debt

A credit card account is charged off after prolonged non-payment, often around 180 days from the last payment. This is an internal accounting procedure by the creditor, indicating they no longer expect to collect the full amount and have removed it from active accounts. Despite being written off, the debt is not forgiven; the consumer remains legally obligated to repay it.

After a charge-off, the original creditor may continue collection efforts or sell the debt to a third-party debt buyer for a fraction of its value. When sold, the debt buyer acquires the right to collect the full amount. This transfer means future collection attempts will come from the debt buyer, not the original credit card company.

Credit Reporting of Charged-Off Debt

A charge-off is a negative entry on a consumer’s credit report, impacting their credit score. This derogatory mark indicates a failure to meet financial obligations, signaling higher risk to lenders. The charge-off remains on the credit report for up to seven years plus 180 days from the date of the original delinquency.

Even if the charged-off debt is later paid or settled, the original charge-off entry does not disappear from the credit report within this seven-year period. Instead, its status will be updated to reflect “paid charge-off” or “settled charge-off.” While a “paid” or “settled” status is viewed more favorably by lenders than an “unpaid” charge-off, the negative impact of the charge-off persists on the credit history for the full reporting period. Paying or settling the debt does not remove the negative mark, but it does show a resolution to the obligation.

Collection Actions and Legal Considerations

Following a charge-off, consumers can anticipate continued efforts to collect the debt, either from the original creditor or a debt collection agency. These efforts include phone calls, letters, and emails seeking payment. Debt collectors are regulated by federal laws, such as the Fair Debt Collection Practices Act (FDCPA), which outlines permissible collection practices and prohibits harassment or deceptive conduct.

Charged-off debt is often sold to a debt buyer. If a debt buyer acquires the debt, they become the party seeking payment and may pursue collection. Consumers should be aware that debt buyers often purchase debt for pennies on the dollar, giving them room to negotiate settlements.

A creditor or debt buyer may also file a lawsuit to obtain a judgment against the consumer for the unpaid debt. If a judgment is granted, the creditor can pursue legal avenues for collection, such as wage garnishment, bank account levies, or property liens, depending on state laws. Consumers facing a lawsuit should seek legal advice, as ignoring the summons can lead to a default judgment.

The statute of limitations for debt collection dictates the maximum period a creditor or debt buyer has to file a lawsuit. This legal deadline varies by state, ranging from three to six years, but can be longer in some jurisdictions. The expiration of the statute of limitations only prevents a lawsuit; it does not eliminate the debt itself, and collection attempts may continue without legal action.

Approaches to Addressing Charged-Off Debt

When faced with charged-off debt, consumers have several options, with negotiation being a key strategy. Creditors and debt buyers are often willing to settle for a lump-sum payment less than the full amount owed, as they have already written off the debt or purchased it at a discount. Settlement offers commonly range from 40% to 70% of the original debt, varying by debt age and creditor policies.

If a lump-sum payment is not feasible, consumers may negotiate a structured payment plan. This involves repaying the debt over months or years through smaller installments. While payment plans might result in a higher total amount than a lump-sum settlement, they offer a path to resolution without a large upfront payment. Get any settlement or payment plan agreement in writing before making payments.

Before negotiating or making payments, consumers have the right to request debt validation from the collector, as per the Fair Debt Collection Practices Act. This request, made in writing within 30 days of receiving the initial collection notice, requires the collector to provide proof that the debt is legitimate and that they are authorized to collect it. Validating the debt ensures the consumer is not paying a debt they do not owe or one that has been misassigned.

Ignoring a charged-off debt carries ongoing implications, including continued negative reporting on credit reports and persistent collection attempts. While the statute of limitations may eventually prevent a lawsuit, the debt remains legally owed. Unresolved charged-off debt can also hinder future financial endeavors, such as obtaining loans, mortgages, or certain types of employment.

Tax Implications of Debt Resolution

When a charged-off debt is settled for less than the full amount owed, the forgiven portion can be considered taxable income by the Internal Revenue Service (IRS). This is “cancellation of debt” income. The creditor or debt collector is required to issue Form 1099-C, Cancellation of Debt, to the consumer and the IRS if the forgiven amount is $600 or more.

The amount reported on Form 1099-C must be included as ordinary income on the consumer’s federal income tax return for the year the debt was canceled. For example, if a $5,000 charged-off debt is settled for $2,000, the $3,000 difference is taxable. However, exceptions and exclusions may apply, allowing individuals to exclude some or all of the canceled debt from their taxable income.

Common exclusions include insolvency, where the taxpayer’s liabilities exceed their assets when the debt is canceled, or debt discharged in bankruptcy. Qualified principal residence indebtedness, related to mortgage debt on a primary home, can also be excluded under specific circumstances. These tax rules can be complex, and consumers should consult with a qualified tax professional to understand their obligations and determine if any exclusions apply.