A debt charge off is a technique that is used by a creditor when they eliminate a portion of debt that they believe they cannot collect. This procedure is used when a debtor will not pay their bill. It can eliminate part of your debt, but it can also harm your credit.
Function
When a consumer has an outstanding balance on a credit account that they cannot afford to pay, the company will try to collect it from them. The creditor will employ a collections agency to try to collect the debt. The debt collector may offer to take less than what you owe and charge off the rest. This means that they write off the remainder of the balance as bad debt.
Misconceptions
Many people mistakenly believe that when a company charges off your debt, you no longer owe it. While you could potentially avoid paying it, you still owe the debt. The company charges it off so that they can get a tax deduction on the amount that they did not collect. You could still pay the debt that is charged off and attempt to salvage your credit history.
Paying Old Debt
Even though a debt is charged off, you can still choose to pay it. If you make payments towards eliminating the debt, this cannot hurt your credit score. If you try to settle your old debt by paying a lump sum that is less than what you owe, this could hurt your credit score. If you are concerned with your credit history, choosing to make regular payments towards the debt would be better for your score.
Taxes
When a debt is settled, you may have to consider the tax consequences. Even though you do not have to pay the debt, you would still be liable for the taxes on this charge off. The Internal Revenue Service looks at a charge off as if you earned income. Since you did not have to pay the debt, your financial situation was improved. This adds money to your annual income and affects your taxes.
Credit Impact
If you choose to engage in debt settlement, it could have a large negative impact on your credit score. In fact, settling a debt could lower your score by as much as 125 points for a single occurrence. If it is possible, you may want to consider setting up a payment plan so that your account does not show any debt settlements. By saving your credit score, you can have a better chance at being approved for financing in the future and pay less in interest on future loans.
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