What Happens When a Credit Card Is Charged-Off?

A credit card charge-off represents a serious financial event, indicating an account holder’s inability to meet payment obligations. It signifies when a creditor formally recognizes a debt as unlikely to be collected. This action has various consequences, impacting an individual’s financial standing and future credit opportunities.

Understanding a Credit Card Charge-Off

A credit card charge-off occurs when a creditor determines a debt is uncollectible and writes it off as a loss on their financial books. This typically happens after a prolonged period of non-payment, commonly between 120 and 180 days of delinquency. Federal regulations often require creditors to charge off revolving credit accounts, such as credit cards, after 180 days of non-payment. This reflects the debt as a loss for the creditor.

Despite being written off, a charge-off does not mean the debt is forgiven or erased. The account holder remains legally obligated to repay the full amount. The creditor, or another entity, can still pursue payment.

Impact on Your Credit Profile

A credit card charge-off significantly damages an individual’s credit score and credit report. Payment history is the most influential factor in credit scoring models, and a charge-off indicates a severe failure to meet payment obligations. This negative mark can cause a substantial drop in credit scores, potentially lowering them by 50 to 150 points.

The charge-off entry remains on the credit report for up to seven years from the date of the first missed payment that led to the delinquency. Even if the debt is later paid or settled, the original negative entry persists for the full seven-year period. The presence of a charge-off can make it difficult to secure new credit, loans, or housing, as it signals a high financial risk to potential lenders and landlords.

Debt Collection and Potential Legal Action

After a credit card account is charged off, the original creditor may continue collection efforts or sell the debt to a third-party debt buyer. This transfers the right to collect the debt to the new entity, meaning the account holder will likely receive collection attempts from a new company.

Debt buyers and collection agencies can pursue various methods to recover the debt, including letters, phone calls, and legal action. A lawsuit can be filed to obtain a judgment against the debtor, which is a court order confirming the debt. If a judgment is awarded, the creditor or debt collector may pursue wage garnishment, bank levies, or property liens on a debtor’s assets, complicating future sales or refinancing efforts.

Tax Implications of Canceled Debt

If a portion or all of a charged-off debt is canceled or forgiven, this amount may be considered taxable income by the Internal Revenue Service (IRS). This can occur if a creditor settles a debt for less than the full amount owed, or if the debt is discharged. When $600 or more of debt is canceled, the creditor or collection agency is generally required to issue Form 1099-C, Cancellation of Debt, to both the debtor and the IRS.

The issuance of Form 1099-C means the canceled debt could be added to the individual’s gross income, potentially increasing their tax liability. However, specific exceptions may prevent canceled debt from being taxable. For instance, if a debtor is insolvent when the debt is canceled, or if the debt is discharged through bankruptcy, the canceled amount may be excluded from taxable income. These exclusions may require filing specific IRS forms.

Pathways for Resolution of Charged-Off Debt

While a charge-off is a serious negative mark, the debt can still be addressed through several pathways. One option is to pay the charged-off debt in full. When this occurs, the credit report entry for the charge-off will typically be updated to reflect it as “paid.”

Another common resolution is to settle the debt for a lesser amount than what is owed. Debt collectors or original creditors may be willing to accept a reduced payment. If a settlement is reached, the credit report will show the account as “settled for less than full amount,” indicating the full obligation was not met.

In some cases, charged-off debt may be discharged through bankruptcy proceedings. If a debt is discharged in bankruptcy, the individual is no longer legally obligated to pay it. This action will be reflected on the credit report, typically remaining for seven to ten years, depending on the type of bankruptcy filed.