Paying all of your debts on time is the best thing you can do to maintain a clean credit report and high credit score. Failing to pay a debt will lead to late fees, account closures and eventually charge-offs listed on your credit report. Once you have a charge-off on your report, you will face negative financial repercussions such as lower scores and difficulty qualifying for loans and credit cards.
Definition of a Charge-Off
When you fail to pay a debt, such as a credit card, the creditor will list your account as a charge-off. Typically, this occurs 180 days after your last payment, according to Bankrate.com. By listing your account as a charge-off, the creditor is stating he no longer considers your debt an asset and has closed your account. The creditor will inform the three major credit bureaus of the charge-off status on the account and may or may not contact you directly.
Financial Obligations
Listing your account as a charge-off does not release you from your payment obligations, and you will still owe the debt to the creditor. In most cases, the original creditor will sell your account to a collection agency. However, some creditors use their own in-house collection agencies. The collection agency or department will try to contact you to pay the debt. In many instances either the original creditor's in-house collection department, or the collection agency, will be willing to settle for a portion of the amount due.
Effect on Credit Scores
Having a charge-off reported on your credit report will have a negative impact on your credit score. If the creditor sells your account to a collection agency, the collection agency will open a file on your credit report as well, which will cause your credit score to drop even further. The charge-off will remain on your credit report for seven years plus 180 days from the date of nonpayment, according to Bankrate.com.
Effect on Personal Finances
Having a charge-off may make it difficult for you to obtain new credit cards, receive credit limit increases or qualify for loans. Allowing your charge-off to remain unpaid may prevent you from getting a mortgage. Many mortgage companies require you to settle your open charge-offs with the original creditor or the collection agency before they will consider your application for a home loan.
Tips
While paying a charge-off account will not remove it from your credit report, it may help you qualify for loans in the future. Before paying any settlement amount with a collection agency or the original creditor, ensure that the company will update the charge-off to read "paid charge-off" on your credit report.
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