What Happens When a Car Loan Is Charged Off?
Understand what happens when your car loan is charged off, affecting your credit, vehicle, and financial future.
When a car loan is charged off, it signifies a significant turning point for a debt, impacting both the borrower’s financial standing and the lender’s accounting. This occurs when a lender determines a debt is unlikely to be collected and writes it off as a loss on their financial records. While this accounting adjustment changes how the debt is viewed internally, it does not mean the borrower is relieved of their obligation to repay the amount owed.
Understanding Loan Charge-Off
A car loan charge-off refers to a lender moving an auto loan from an active asset to a liability on its books, recognizing it as a loss. This typically happens after a prolonged period of non-payment, often ranging from 120 to 180 days past the due date. This classifies the debt as uncollectible through normal means.
A charge-off does not equate to debt forgiveness; the borrower remains legally obligated to repay the full amount of the loan. The lender simply ceases to carry the loan as an expected income stream. After a charge-off, the original lender may continue collection efforts directly or sell the debt to a third-party collection agency.
Impact on Your Credit and Debt
A charged-off car loan has a severe negative impact on a borrower’s credit report and overall financial health. The charge-off is recorded as a derogatory mark, signaling to other creditors that the borrower failed to fulfill a financial obligation. This negative entry typically remains on the credit report for up to seven years from the date of the first missed payment that led to the charge-off.
A charge-off can significantly lower a credit score, potentially by 50 to 150 points or more. This damaged credit score makes it challenging to obtain future loans, such as mortgages, new car loans, or even personal loans. If approved for credit, borrowers will likely face much higher interest rates and less favorable terms. A poor credit history can also affect other areas of life, including the ability to rent housing or pass certain employment background checks.
Once a car loan is charged off, the original lender often transfers the debt to an internal collections department or sells it to a third-party debt collection agency. The new debt holder will then pursue repayment of the outstanding balance through persistent phone calls, letters, and other communications.
Vehicle Repossession Process
For car loans, which are typically secured by the vehicle itself, repossession is a highly probable outcome when payments are not made. The lender can seize the vehicle if the borrower defaults on the loan terms. Repossession can occur before or after the loan is charged off, depending on lender policies and state laws.
The lender or a contracted repossession agent physically retrieves the vehicle. Borrowers are provided with notice of the repossession and information regarding the subsequent sale. The repossessed vehicle is commonly sold at an auction, and proceeds are applied to the outstanding loan balance.
The auction sale price may be considerably lower than the vehicle’s market value or the remaining loan balance. After the sale, any costs associated with the repossession and auction are deducted from the proceeds. The borrower remains liable for any remaining balance after these deductions.
Ongoing Debt Obligations
Even after a car loan is charged off and the vehicle has been repossessed and sold, the borrower’s financial responsibility often continues. A “deficiency balance” is the remaining amount owed on the loan after the sale proceeds of the repossessed vehicle have been applied and all costs of repossession and sale are subtracted. The borrower is legally obligated to pay this deficiency balance.
The original lender or the debt collection agency will continue to pursue this deficiency balance. This pursuit can involve various collection tactics, including legal action. Creditors or collection agencies may file lawsuits to obtain a judgment against the borrower. If a judgment is granted, it can lead to more aggressive collection methods, such as wage garnishment or bank account levies, depending on state laws.
There are also potential tax implications if a portion of the charged-off debt is forgiven. If the lender settles for a reduced amount or decides not to pursue the deficiency balance, this forgiven amount may be considered taxable income by the IRS. The borrower might receive a Form 1099-C, Cancellation of Debt, reporting the amount of debt that was forgiven. This form is typically issued when the canceled debt reaches a certain threshold, currently $600 or more.