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How 'Charge Offs' Effect You
by Gary Foreman
Question: Can you describe
or define what the term "charge off" means concerning credit cards and
credit reports? I am seeing it quite often and do not quite understand
what it signifies.
Thanks for your help.
Patty
Louisiana
Answer: Patty's right. You are seeing the term "charge off" more
frequently. That's because about 1% of all credit card debt is
ultimately charged off. And, whether you struggle to make credit card
payments or you have a perfect credit history, charge offs will effect
your finances.
Let's begin by finding out what a charge off really is. Wachovia Bank
offered a good definition on their website <wachovia.com>: "The removal
of an account from a credit card issuer's books as an asset after it has
been delinquent for a period of time, usually 180 days. When an account
is charged off, the credit card issuer absorbs the outstanding balance
as a loss."
For those of you who don't speak 'financialese' that means that a
'charge off' or 'write off' is really just an accounting entry. The
lender is saying that they don't expect to collect the debt and are not
willing to claim it as an asset of the company any longer.
But it will not affect whether the borrower still owes the money. A
charge off does not free you from the debt. Think of it this way.
Suppose you borrowed $100 from Joe. After a year passes he doesn't
really expect to get his money back. Mentally he's 'written off' the
loan. He doesn't believe that your IOU has value any more. But, that
doesn't mean that you don't still owe Joe $100. You do.
In fact, in the world of credit card debt it's possible that it will be
harder to avoid paying the debt after it has been written off. That's
because the original lender often sells those debts to a third party
when they write them off. And the third party, often a collection
agency, gets to keep any money that they collect. So they will work very
hard to collect as much as they can. Even if that means using
questionable pressure tactics.
Note that it's the lender who gets to decide whether to write-off a debt
as being uncorrectable. You may have lost your job six months ago and
not made a payment since. But you really plan on making one next month.
That doesn't prevent the lender from writing off the debt.
On the other hand, in approximately 50% of the cases charge offs occur
when a borrower declares bankruptcy. Between one and 1.5 million people
declare bankruptcy each year. Their bankruptcy triggers the charge off.
So what happens to your credit rating when your card balance is written
off? Thirty-five percent of your credit score is based on past payment
history. A 'charge off' is about the worst mark that you can get on your
credit report. It says you are someone with a history of not paying
their debts.
And you don't need a charge off to be penalized. If you struggle to make
your minimum payment, the fear of a write off will cause the credit card
company to raise your interest rate. Based on a borrower's payment
history they can predict when someone is becoming a high risk. When that
happens they'll increase the interest rates on the account very quickly.
That costs you more money every month.
OK, what happens if you always pay your bills on time? Unfortunately,
you're still effected by charge offs. The credit card companies expect
that some loans will not be repaid. So in an effort to stay profitable,
they have to charge everyone a little higher interest rate to make up
for the losses. So everyone who uses a charge card makes some small
contribution.
One final issue. If you do have a charge off on your record you might
want to consider repaying the debt if you have the money. Negative
remarks will be stay on your report for 7 years. You may be able to
negotiate a deal where you pay the debt and the lender changes the
status of the account to "Paid as Agreed". If you attempt to do this,
make sure that you get the agreement in writing.
Thanks to Patty for a good question!
About the author
Gary Foreman is a former financial planner who currently edits The
Dollar Stretcher website
www.stretcher.com
and ezines. You'll find thousands of articles to help you save time and
money. copyright 2003 Dollar Stretcher, Inc. All rights reserved.
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