When a bank or credit charges off your credit account, the bank conducts a number of accounting procedures to take that debt off its books. That doesn't mean you are off the hook for paying on the debt. The bank can choose a number of options that can leave you with a bill and mounting fees. No matter what, your credit report will take a beating, and other lenders will consider you a credit risk. You also have a few options, however, to mitigate the damage of a charged-off line of credit.
Charge-Off Facts
A charge-off is any debt that is so long overdue that the bank no longer considers it an asset. According to Bankrate.com debt adviser Steve Bucci, creditors usually charge off outstanding accounts by 120 to 180 days of trying to collect from you. The debt then no longer appears on its balance sheet, and the bank considers the debt a business loss, says popular financial adviser Suze Orman. You still owe the money, however.
The Bank Can Sell the Debt to a Collector
After the bank has used considerable resources to contact you and get you to pay your debt, the bank often sells the debt to a collection agency. Collection agencies can typically purchase large amounts of debt for pennies on the dollar and then use more aggressive techniques to get you to pay. They may call you more frequently, send you collection letters, contact your references and tack on fees to the debt you owe.
Your Credit Will Take a Hit
Suze Orman says most banks will change the status of your line-of-credit account to R9 or I9. This is a damaging status. Your payment history accounts for 35 percent of your credit score according to the Fair Isaac Co. This status can remain on your report for seven years from the time you started to default, says Bucci. In addition, if the bank has sold the debt to a collection agency, that agency can also report your account activity on your credit report, often as a separate item from the original credit account. You could have two negative credit entries for one line of credit.
What You Can Do
Negotiate with your bank. If the bank hasn't sold the account off to a collection agency yet, you may have a little more wiggle room to protect your credit. Dave Ramsey, noted finance guru says you should make every effort to work out a payment plan with the original creditor to avoid a "debt snowball." If the debt has already been transferred to a collector, Bucci says you should demand that collect verify that the debt is yours and the collect has the authority to collect it from you. Then you need to negotiate and get all payment terms in writing. You also want to negotiate the status of the entry on your credit report. Terms like "Paid in Full," "Paid as Agreed" may be more beneficial to you than "Settled" or "Paid Charge-off." Keep watch over all your credit reports to make sure the collection agency reports the way you agreed and to ensure no other errors are being reported about the line of credit.
You Might Have to Report Extra Income
Chances are your account got charged off because of your inability to pay. The bank or collection agency agrees to settle the account for less than you owe, but you may be hit with a tax bill. The amount that is "forgiven" can be reported to the IRS as a "discharge of indebtedness," says Forbes.com. This could be considered earned -- and taxable -- income. If you receive a 1099 form from the bank or collection agency, you will need to report this income. There are exceptions, for example, if you are bankrupt or could argue that the forgiveness was a gift, but it's best to talk to a tax specialist if this happens to you.
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