You may have received a credit alert that your credit score has decreased due to a charge off. But what is a charge off and how do charge offs affect your credit score?
What is a charge off?
Let’s say, you have a credit card and you don’t pay on it for several months. Usually, after 90 or 120 days, the credit card company will close the account. In addition, the company will write that debt off their books. This is a charge off. This doesn’t mean that you no longer owe the debt. You are still liable for the debt.
When a company deems that they can no longer collect the debt, the debt becomes an asset. The company has to take the asset off its books because the IRS does not allow them to count this asset forever. Then is when the charge off occurs. In short, it means that even though you still owe the company, they can no longer list it as an open asset.
How do charge offs affect your credit score?
There are several ways a charge off can affect your credit score. First, before the charge off is reported on your credit report, your credit score will drop. Since a charge off occurs after several missed payments, your payment history will suffer. Payment history is the largest factor in calculating your credit score. Once the charge off is added to your report, another negative mark will reduce your score. Both late payments and charge offs can remain on your report for seven years.
The second most significant factor of determining your credit score is credit utilization. Even though the account is closed, charge offs still affect your credit utilization. In most cases, due to missed payments, interest is accrued. In this case, the charged off account will reflect that you are over the limit. Even worse, if left unpaid, the charge off can be sold to a collection company.
As a result, many lender may not be willing to extend you credit. They will fear that you may not demonstrate your willingness to pay debt.
How to remove charge offs?
The best way to remove a charge off is to work with the creditor. Even if you do not have the funds to pay the debt off in full, make payment arrangements. Making payment arrangements shows your willing to resolve the matter. More important, it keeps the account from going into collections. In addition, the payments will reflect a decreased balance for that account. This can have a positive impact on your credit score. In some cases, you can negotiate to remove the charge off once you have paid the balance owed.
You may have the ability to resolve the debt for less than owed. Each state has a statue of limitations for debt. Check with your state for details. If the account is past the statue of limitations, the creditor can no longer attempt to collect the debt. This does not mean that you do not owe. It means the creditor can no longer sue you for the debt. In most cases, creditors will be willing to setter for less.
However, there is one drawback. If the debt is forgiven or you pay less, the IRS can consider this as income. If the amount forgiven is more than $600, you will receive a 1099-C from the creditor. Which means you owe taxes on that money.
