What is a charge-off?

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Oftentimes the language used in credit reporting can be confusing to consumers. Charge-off is one of those somewhat baffling terms. Let’s look closely at credit card charge-offs and what they mean in regards to your credit reports and scores.

Charge-off is the term used in credit reporting to mean that an account has gone continuously unpaid for a sufficient amount of time—usually around 180 days—and the creditor’s accountants or regulators determine that the account is never going to be repaid and must be closed. Up to this point the account has counted as an asset on the creditor’s balance sheet.

When it is deemed uncollectable, it can no longer be counted as an asset and is “charged-off.” While that kind of sounds like they have written your debt off, that’s not all there is to it. The write-off is purely an accounting function that applies only to the company’s balance sheet, not your debt.  You still owe the bill, and they still expect you to pay it.

How does a charge-off affect your credit score?

In a word, badly. Charge-offs by their very nature imply that you haven’t paid your bills. As you know, payment history is the No. 1 factor in FICO scoring and accounts for 35 percent of your total score. Charge-offs usually happen after about six months of non-payment. So, for every month the account gets further behind, your score takes another hit. And because it’s a numbers game—going from 60 to 90, then 90 to 120 and so on—means harder hits every single time. By the time a charge-off happens, your credit score will have significant damage (second only to bankruptcy). Once you cross that 180th day, the charge-off does major damage—even if you had a good score to begin with.

Do you still have to pay?

Once an account is charged-off, your debt will likely be handed over to a third party or outside collection. If that happens, your credit report will reflect a zero balance on the charge-off, probably with a note saying “sold to” or “transferred to” and the name of the collection agency. You’ll also have a new line called “collections” that shows the balance due, a note on the account saying “transferred from” or “sold to” and the name of the collection agency.

Let me be very clear here: Charging-off a balance does not relieve you of your responsibility to pay. It may change who you have to pay but it does not erase your debt or the fees. Plus, interest may continue to accrue.

As long as there is an amount listed under the charge-off, you can contact the original creditor to make payment arrangements. But once it moves to collections, you will likely have to work with the collector. Also, you should know that once a charge-off happens, it will remain on your credit report for seven years after the date of the original or first delinquency, whether you pay it off or not.

The same is true of collections, which are treated as an extension of your loan from the original creditor and will be deleted at the same time in seven years. Some future lenders may look more favorably at a charge-off paid notation—which is one good reason to come up with a way to pay the debt. No matter what, though, you will still owe the money.

You should know that both FICO 9 and VantageScore 3.0 ignore paid collections in their algorithms. But you should also know that older versions are still in use by many, so you can’t count on that. But remember that future lenders may look more favorably on a charge-off that was paid.

Can you still get a credit card after a charge-off?

You will probably still be able to get a credit card after a charge-off but you may be charged higher interest rates and fees. There is no law that says creditors have to offer you credit. Each lender will look at your situation from their own point of view and risk tolerance. What they decide to offer you—if anything at all— is totally up to them.

If all else fails, you can apply for a secured credit card to get you back in the credit card game. Using your own money as collateral, these cards look and function the same as any other credit card. If you must go this route, be sure to choose a card that reports to the credit bureaus so that the work you do to improve your credit standing is noted.

How to recover from the credit score damage

As with all things credit reporting and score-related, getting positive data onto your credit report after you have done some damage is the very best way to recover. This starts with paying all your bills on time, every time. I highly recommend figuring out a way to repay any charge-offs you have. Again, even if it still counts against you for a while, future lenders will see that you have been working to make it right.

Also, watch your credit card usage on any accounts you still have open and work to reduce your utilization to below 25 percent. The lower you can go, the better for your score. And don’t close old accounts unless you must.

See if you can diversify your credit mix by adding an account with a fixed payment if all you have are credit cards. But be careful here, because you should open new accounts only on an as-needed basis.

Here is where something like a passbook loan may be a good solution, since you won’t be going into debt to establish another credit line on your credit reports. Just like with a secured credit card, you will want to be sure that the loan issuer reports to the credit bureaus before you choose this route.

The bottom line

If at all possible, you should avoid charge-offs and the resulting collections. If you need help paying your credit card, don’t wait to reach out to your creditor and ask about a hardship program. Although that is generally a short-term solution, it could be the answer that will keep you from facing a charge-off in your future.

Have a credit score question for Steve? Drop him a line at the Ask Bankrate Experts page.