What Happens When Your Credit Card Is Charged Off?

When a credit card account becomes severely delinquent, the creditor may eventually classify the debt as a “charge-off.” This accounting action signifies that the creditor has determined the debt is unlikely to be collected and has removed it from their active accounts as an asset. While a charge-off does not eliminate the debt obligation, it sets in motion a series of events that significantly impact an individual’s financial standing.

Understanding a Credit Card Charge-Off

A credit card charge-off occurs when a creditor formally recognizes an unpaid debt as a loss on their financial books. This typically happens after an extended period of non-payment, often around 180 days past the original due date. Prior to this, the account progresses through various stages of delinquency, incurring late fees and potentially higher interest rates.

Even though the creditor “writes off” the debt for accounting purposes, the consumer remains legally responsible for the amount owed. A charge-off is an internal accounting classification and does not mean the debt has been forgiven or erased. It signifies that typical collection efforts have been unsuccessful.

Immediate Consequences of a Charge-Off

Once a credit card account is charged off, the original creditor will close the account, making it unusable for any further purchases or transactions. The original creditor may then cease their direct collection attempts.

Following the charge-off, the debt is frequently sold to a third-party debt buyer or assigned to a collection agency. These entities acquire the right to collect the debt, often for a fraction of its original value. The underlying debt still exists and must be repaid, despite any change in ownership or collection responsibility.

Impact on Your Credit Profile

A charged-off account inflicts substantial negative consequences on an individual’s credit report and credit score. It appears as a severe derogatory mark, indicating a significant failure to meet financial obligations. This negative entry remains on credit reports for up to seven years from the date of the first missed payment that led to the charge-off.

The presence of a charge-off can lead to a considerable decrease in credit scores. Payment history constitutes a significant portion of credit scoring models, accounting for approximately 35% of a FICO Score. A charge-off, representing multiple missed payments, severely impacts this crucial factor. This damage can hinder future access to various forms of credit, including new credit cards, personal loans, mortgages, and may affect housing applications or employment opportunities.

Addressing a Charged-Off Account

Individuals facing a charged-off account have several options for resolution. One approach is to negotiate a settlement with the original creditor or the debt collector. This often involves agreeing to pay a reduced amount in a lump sum, which can save money compared to the full balance. While settling can resolve the debt, the credit report will reflect the account as “settled” rather than “paid in full,” indicating a deviation from the original terms.

Alternatively, it is possible to arrange a payment plan with the debt holder, allowing for repayment over time through scheduled installments. When communicating with debt collectors, request verification of the debt. The Fair Debt Collection Practices Act (FDCPA) grants consumers the right to request validation of the debt within 30 days of initial contact, requiring the collector to provide proof of the debt’s legitimacy before continuing collection efforts.

Potential Legal and Tax Considerations

A charged-off debt does not preclude legal action. Debt collectors or the original creditor can file a lawsuit to pursue the outstanding balance, especially if collection efforts have been unsuccessful. If a lawsuit is successful, a court judgment may be issued against the debtor, which can lead to actions such as wage garnishment. Federal law imposes limits on how much of an individual’s disposable earnings can be garnished.

There are also potential tax implications if a portion of the charged-off debt is forgiven or settled for less than the full amount. The Internal Revenue Service (IRS) considers canceled debt as taxable income. If a creditor forgives $600 or more of a debt, they are required to issue Form 1099-C, Cancellation of Debt, to both the debtor and the IRS. This amount must be reported as income on the individual’s tax return, unless an exception or exclusion applies.