What does it mean if your debt is charged off as bad debt?

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If you’ve been delinquent on your credit card or loan payments for multiple months, you might have noticed a charge-off on your credit report. At first glance, it might look like a free ticket that no longer holds you responsible for the debt.

The reality is that creditors can still attempt to collect charged-off debt. Here’s what you need to know about what a charge-off is, what your liability might be and what it means for your credit.

What is a charge-off?

When a debt is charged off, it’s taken off the creditor’s balance sheet. This generally occurs when a payment is between 90 and 180 days past due. If no payment is made by this time, the creditor assumes that the debt is unlikely to be paid in the near future. Since the delinquent debt can’t be carried on the creditor’s books as a current asset, the creditor marks the debt as “charged off.”

A charge-off in no way erases the debt that you owe. It still exists, and you’re still liable for it. The creditor or a debt collection agency can also still attempt to collect on a charged-off debt. Each state has a statute of limitations law that limits how many years a debt collector can legally sue you to collect in court.

The laws vary by state and depend on the type of debt that’s charged off. Be aware that some collectors may still attempt to collect by phone and mail, even if they don’t have the option of suing in court.

How does a charge-off as bad debt affect your credit report?

Creditors often report charged-off accounts to the credit bureaus. A charge-off as bad debt reflects poorly on your past payment history. Considering that 35 percent of your FICO score is based on payment history, you can expect your credit score to be adversely affected.

Besides damaging your credit score, an unpaid charge-off can harm you when you want to make a major purchase using credit, rent an apartment or apply for a job. Businesses may be wary of someone with any long-term, unpaid credit accounts.

If you decide to pay the charged-off account, the derogatory mark still won’t drop off of your credit history. Instead, it might show up on your report as a “paid charge-off.” This might help your score slightly, depending on the scoring model that’s used, but could still be a red flag for future creditors.

Charged-off accounts and other negative marks stay on your credit reports for seven years. So if you choose not to pay, you will have to wait that long for the charge-offs to stop affecting you.

What to do if you have a charge-off

By law, creditors and debt collectors are required to provide the unpaid debt’s details in writing. This written correspondence is called a “validation notice” and is required within five days of contacting you. The letter or notice should include the amount you allegedly owe, the name of the original creditor and instructions about how to contest the debt if it’s not yours.

Once you receive the validation notice, ask yourself the following:

  • Is the account mine? Make sure that the charged-off debt is actually yours. If you have a common name or have a relative with the same name (e.g., those using the suffix “Jr.” versus “Sr.”), a mix-up regarding who the debt belongs to might have occurred.
  • Is the account actually unpaid? If you know that the account belongs to you but don’t remember having an unpaid debt, consult your payment records. An accounting error may have happened on the creditor’s end, especially if the account is old.
  • Is the debt past its statute of limitations? Ask the creditor for the last payment date noted on the account. Legally, they’re required to answer honestly if they know. If the debt is older than the statute of limitations in the presiding state, you may not have to worry about being taken to court. However, creditors can still contact you to collect the debt, and the account will still be reported on your credit report for seven years.

Ultimately, if the charge-off account does belong to you, you’re legally responsible for paying the debt. Some collectors agree to settle for a reduced amount, and you might decide to pay the settlement amount. If the debt is nearing or past its statute of limitations, you might choose to not pay the charged-off account. It’s best to consult with a debt attorney about the option that’s best for you.

Tips to avoid charge-offs

As much as possible, it’s best to avoid having an account charge-off as bad debt altogether. A few ways to stay in good standing with your creditor include:

  • Working out a payment plan. Many creditors would rather work with you on a manageable payment plan than not receive payment on the debt at all. If you’re facing financial hardship, contact your creditors as soon as possible before your next payment is due.
  • Creating a budget. Put together a monthly budget based on your recurring bills and personal goals. If you can, build up an emergency fund to cover at least six months’ expenses in the event of unexpected expenses or unemployment. Then assess whether you can afford to borrow on credit.

The bottom line

A charge-off doesn’t absolve you of the debt you owe. You’re still legally responsible for the unpaid debt, and it’ll take time for your credit score to fully bounce back from a charged-off account. But addressing a charge-off as quickly as possible can help triage the impact it has on your future credit standing sooner than later.

Featured image by Drazen Zigic of Shutterstock.

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