A charge-off account is any debt that the original creditor removes from its accounting ledger and categorizes as "uncollectible." Although most people use this term to refer to credit card accounts, hospital debts, small business debts and unsecured personal loans can also be charged off. Most companies periodically charge off bad debts for tax purposes.
Facts
A creditor that charges off a debt has the right to retain ownership of the debt, but most do not. By selling the debt to a collection agency, a creditor can recover a portion of the outstanding account balance and write off the remainder as a loss on its annual profit and loss statement. Charging off a debt does not in any way invalidate it or absolve the consumer from his obligation to pay off the balance in full.
Features
Some companies choose not to sell the debt to a collection agency and instead write off the full amount owed as a loss. Should this occur, the company will then file a Form 1099 with the IRS noting that it "forgave" the debt following a charge off. It must then send Form 1099-C, noting the full amount of the written off debt, to the debtor. Form 1099-C requires the individual to include the charged-off debt as income on her tax return.
Significance
If a creditor files regular reports with the credit bureaus, a charge-off results in significant credit damage for the nonpaying consumer. The Fair Isaac Corporation's website, myFICO.com, notes that each consumer's payment history record determines approximately 30 percent of his credit score. Thus, the missed payments prior to the charge-off will severely damage the debtor's credit rating. The Fair Credit Reporting Act, which contains laws that regulate the credit reporting industry, notes that late payments and charge-offs remain within a debtor's credit report for seven years.
Effects
Most lenders use an individual's past credit history as an indicator of whether or not she is likely to repay borrowed funds. A damaged credit history due to a charge-off causes future lenders to view the debtor as a much higher risk and charge her higher interest rates as a result. Some lenders will decline new applications for credit or loans based on a previous charge-off.
Warning
Collection agencies that buy charged off debts use standard collection methods such as collection letters and frequent telephone calls. Depending on the amount the debtor owes, however, the collection agency that owns the account may file a lawsuit against him and obtain a civil judgment. In most states, this gives the collection agency garnishment rights. In addition to seizing the consumer's bank accounts and a portion of his wages through garnishment, if the debtor owns real estate, the collection agency may also place a real estate lien against his property -- forcing him to pay off the previously charged off debt before selling or refinancing his home.
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