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Because 35% of your credit score relates to paying your debts in a timely manner, becoming so late on payments that the account is charged off can have a significant negative impact on your score. It also looks bad to future creditors because it indicates you might not pay all your bills. Find out more about charge offs and how they affect your credit score.

What Is a Charge Off?

A charge off occurs when a business writes debt off their books. It’s an accounting procedure that occurs for a specific reason.

When you owe a business money, the company counts that debt as an asset. The older the asset becomes, the less valuable it is because older debt is less likely to be collected. Eventually, the company has to take the asset off its books because the IRS doesn’t allow it to count this asset forever. That’s when a charge off occurs.

A charge off doesn’t mean that you don’t owe the debt. It only means that the company is no longer listing it as an open asset.

How Do Charge Offs Impact Your Credit History?

Companies report charge offs to the credit bureaus. When that happens, the applicable account is listed as charged off. Because you have to miss a large number of payments to have an account charged off, your credit score is likely already lowered due to a poor payment history. The charge off may lower it a bit more.

In addition to bringing your credit score down, a charge off looks bad to any future lenders that review your credit history. Lenders that might be willing to offer funds even though you have a lower credit score might balk if they see the charge off. That’s because a charge off demonstrates that you did not make any effort to pay the debt for some time.

How Long Does a Charge Off Stay on Your Credit Report?

Charge offs can stay on your credit report for up to seven years.

The older an item is on your credit report, the less impact it has on your score. That means you can raise your score even after a charge off if you manage finances and credit responsibly going forward. However, an unpaid charge off still looks bad to potential creditors and can limit your options when it comes to loans such as mortgages.

Can Creditors Attempt to Collect Charged Off Debt?

Charge offs don’t mean your debt was forgiven. You still owe the debt, and the company can still attempt to collect the debt.

In many cases, the original lender considers charged off debt to be “bad debt.” That means the lender doesn’t believe it has a good chance of collecting the debt and it’s not worth continuing to use internal resources to do so. Common actions taken by lenders at this point include selling the debt to a collections agency or contracting with a collection agency to collect the debt for them. Creditors can also take legal actions to collect these debts, including judgments.

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Should I Pay Charged Off Amounts?

Making arrangements to pay a charged off account removes you from the collections process. That means you don’t have to worry about collectors or legal collection activity in the future. But it might also provide a positive impact for your credit report.

In some, admittedly rare, cases, you may be able to negotiate with a creditor to remove the charge off from your credit report if you pay the balance owed. Even if that’s not the case, though, it could be worth making payment arrangements.

Once you pay a charged off account, the creditor changes the item on your credit report so it shows up as a charge off that was paid. It’s still a negative item as far as timely payments go, but it demonstrates that you do attempt to pay all your debts. That can make you appear to be a less risky borrower in the eyes of some lenders.

Should I Pay a Charge Off in Full or Settle?

In some cases, creditors will agree to accept less than the amount you current owe in payment for a charged off balance. Many times, the balance is inflated by finance fees, late charges, and other expenses, leaving the creditor room to accept a lower amount. Plus, if it comes down to partial payment or no payment, creditors may be willing to accept what you can pay.

However, this can come with one disadvantage. The amount the creditor agrees not to collect from you is considered forgiven debt. Many forgiven or canceled debts are considered income by the IRS, which means you may owe taxes on them come tax time. Consult with an attorney or tax adviser before agreeing to partial debt forgiveness.

Keeping an Eye on Your Credit Report and Score

Whether you’re dealing with a current charge off or you’re working to continue raising your credit score years after a charge off, knowledge is important. When you know what’s going on with your credit history, you can work smarter to improve your score. Sign up for ExtraCredit from Credit.com to get 28 FICO scores and a detailed look at how you’re doing across the five factors that feed your score.