A charge-off occurs when a creditor purges a delinquent debt from its active accounts database. This limits the creditor's financial losses since the company can then classify the unpaid debt as an expense, rather than an asset for tax purposes. While all banks have the right to sell unpaid debts to collection agencies, owing an unpaid credit card or loan balance to a bank does not guarantee that your account will end up with a debt collector.
State Laws
Some states, such as Oregon, maintain laws requiring banks to charge-off delinquent accounts within a certain time. Even if state laws don't force a bank to charge-off nonperforming accounts, doing so is advantageous to the bank due to the business tax deduction that the charge-off provides. Most banks charge-off unpaid credit cards and loans after 180 days, but this period may vary depending on state laws and each individual bank's policies.
Financial Benefits
Selling charged off accounts to collection agencies benefits the bank financially because, not only does it receive a tax break, selling the account allows the bank to recover a portion of the unpaid balance. How much the bank receives from the collection agency may vary depending on factors such as the amount the consumer owes, the age of the debt and how much supporting documentation the bank can provide to the collector.
Debt Recovery Lawsuit
If a bank has reason to believe that an individual possesses the assets to pay off the debt, it has the option to charge-off the account and pursue the debtor in court without the assistance of a third-party collection agency. Unless the debtor fights the lawsuit and wins, the bank receives a civil judgment from the court allowing it to seize the individual's assets in lieu of payment.
Bankruptcy
A debtor who files for bankruptcy receives the court's protection from all creditors through a legal event known as the "automatic stay." When the bank receives notice of the debtor's pending bankruptcy case, all collection activity must immediately cease -- including selling a charged off account to a collection agency. Federal law requires all creditors to adhere to bankruptcy's automatic stay or face legal consequences.
Considerations
After a bank sells your debt to a collection agency, the amount you owe will likely increase since collection agencies can add fees and sometimes interest charges to the balances they purchase. In addition, the collection agency will report the account to the national credit reporting agencies -- tarnishing your credit history and lowering your score. Even if you cannot afford to pay your delinquent debt in full, negotiating a settlement or payment plan with the bank before it sells your debt helps you avoid the unpleasant consequences of owing a debt to a collection agency.
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