How Credit Card Charge-offs Happen

Late payment entries on your credit report progress in 30-day increments. So, one late payment is 30-days late; two late payments are 60-days late. Once your credit card reaches 180 days late, you’ve missed six credit card payments.

As long as your account is current, credit card companies consider your balance to be an asset to the company. However, when you reach 180 days late, your debt is now considered a liability for your credit card issuer. As an accounting practice, the credit card company writes off your debt on their books and calls it a charge-off.

The charge-off listing is added to your credit report, letting future creditors and lenders know your debt got so late the credit card company had to write it off.

A charge-off is one of the worst things that can appear on your credit report. It will devastate your credit score and can take years to repay.

You Must Pay a Charge-Off

Even though the word “charge-off” sounds like you’ve been forgiven for the debt, that’s not the case. You owe a credit card charge-off just like you owe your current credit card balances. Once your account has been charged-off though, your credit card company may not spend anymore time trying to get you to pay the debt. Instead it will hire a third-party debt collector to work on getting you to pay.

Charge-Off Listings Affect Your Credit Report and Credit Score

A charge-off will remain on your credit report for seven years and 180 days from the time your account first went delinquent. Even if you pay off the charge-off, your credit report will still reflect the fact that your account was once charged-off. The only thing that makes it better is that it becomes a Paid charge-off rather than an unpaid one.

It is difficult to get a charge-off removed from your credit report. You may be able to negotiate with the credit card company to remove the charge-off listing in exchange for payment. But, the credit card company has little incentive to agree to this. Not only that, credit card companies have an agreement with the credit bureaus to provide accurate information about your accounts.

The glimmer of hope is that some consumers have been able to work with their credit card issuers to remove the charge-off if they paid the account. It’s a matter of talking to the right person at the right time.

Settling Charged-Off Credit Card

If you can’t convince the creditor to remove the charge-off, consider negotiating a lower payment amount. This is called “settling your debt.” When you settle a credit card account, your creditor agrees to accept a lower payment to satisfy the debt. From the credit card company’s perspective, something is better than nothing. For you, it means you part with less money than you actually owe.

Be careful about settling a credit card charge-off. Your credit card issuer is required to let the IRS know about any debt above $600 that’s cancelled. In turn, you’re required to report the cancelled debt as income on your next tax return. That could mean you owe taxes or receive a lower refund than you would have otherwise.

If you settle a charge-off, your credit report will be updated to show the account was settled rather than paid in full. This could hurt your credit score as long as it appears on your credit report. Fortunately, the negative entry will fall off after seven years from the date the account was charged off.

Benefits of Paying as Charge-Off

Whether you pay a charge-off in full or you settle the account, you shouldn’t leave the charge-off unpaid. If you don’t pay a charge-off, it can impact your ability to get credit cards and loans in the future. That means you’ll have difficulty purchasing a house or a car. Not only that, you could pay higher insurance rates, be turned down for a job or promotion, and you could even have difficulty renting an apartment.

Once the charge-off is paid, collection efforts on the account will stop. You don’t have to worry about getting calls and letters from debt collectors.

How to Avoid a Credit Card Charge-Off

You can avoid a charge-off by making at least the minimum payment on your credit card each month. Make sure you let your credit card issuer know your current mailing address so you receive your billing statements in time to make your payment. Or, if your credit card issuer has the option, you can sign up for paperless billing.

If you notice you have trouble making your credit card payments, contact your credit card issuer ahead of time. Your card issuer may offer a hardship program that lowers your interest rate or monthly payments to make your payments more affordable. Or, you may take advantage of consumer credit counseling which will help you negotiate a lower interest rate or minimum payment if your card issuer doesn’t have a hardship program.

Avoid using cash advances, balance transfers, and payday loans to pay your credit card bills because create more credit card problems than the charge-off itself.

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Credit card minimum payments are typically between 2% to 5% of your credit card balance. On a credit card with a $1,000 balance, your minimum payment will be anywhere from $20 to $50. Even though paying the minimum payment might be convenient, it’s not the best way to pay off your credit cards for several reasons.

Paying the Minimum Takes Longer and Costs More

When you make minimum payments on your credit card, you’re only making small dents in the balance. It’s like moving a mound of sand using only a spoon. It will take a very long time. For example, if you make minimum payments on a $5,000 credit card balance (with an 18% interest rate) it will take you 23 years to pay off your credit card balance.

The reason that minimum payments don’t do much for your credit card balance is because most of the payment goes toward the monthly finance charges. So your balance goes down, very slowly. The higher your balance and interest rate, the longer it takes to pay off your credit card with minimum only payments.

In the 23 years you spend paying off your $5,000 credit card balance, you will end up paying more than $13,000 in total (with an 18% interest rate). That’s more than double the amount of the original balance. You’ll end up paying more than $7,000 in interest alone.

If you doubled your minimum payment and paid $250 toward your credit card balance each month, you’d pay off the balance in 2 years and only pay $989 in interest. You save more than $6,000 sending just $125 more each month. Think of all the things you can do with an extra $6,000.

Your Credit Card Balance Could Go Up

In some situations, your credit card balance could go up instead of down when you’re making minimum only payments. That can happen when you have a high interest rate and a low minimum payment. For example, if you have a $1,000 credit card balance at the default rate of 30% (the rate charged when you make a late payment or exceed your credit limit) and a 2% minimum payment, your finance charge would be $23 while your minimum payment would be $20.

When your minimum payments don’t cover interest, your balance goes up and so does your interest charges. This type of situation makes it impossible to pay off your credit card balance. You must pay more than the minimum to get your credit card balance to go down. Pay attention to your billing statement, especially your finance charge and minimum payment to see if you’re in this minimum payment trap.

Your Credit Score Could Suffer

If your credit card balance is high compared to your credit limit, making minimum payments is probably hurting your credit score. Part of your score is based on your credit utilization, the ratio of your credit card balance to credit limit. Low credit card utilizations are better.

Keeping your balance below 20% of your credit limit is best. If you’ve already exceeded that 20% credit utilization and you’re only making minimum payments on your credit card, it will take a long time for your credit score to recover. In the meantime, you have new applications for credit cards and loans denied because of your high credit card balances and low credit score.

Calculate Your Minimum Payment Timeline

If you want to get a rude awakening about how much minimum payments are costing you, use an online credit card payment calculator. These calculators tell you how much interest you’ll ultimately pay and how long it will take to pay off your balance when you pay the minimum only. You’ll also be able to compare minimum payments to a higher, fixed monthly payment to see how much money and time you’ll save by increasing your monthly payment.

• Bankrate
• CreditCards.com
• Dinktown.com (lets you compare minimum payments on multiple credit cards)

Is It Ever Ok To Pay the Minimum?

You may have an excuse to make minimum payments on your credit card if you’re working on a debt repayment plan where you focus on paying off one credit card at a time. With this type of credit card payoff you send a large, lump sum payment to one of your credit card until that card is completely repaid. Meanwhile, you send the minimum payment to all your other credit cards. Then, once one credit card is repaid, you begin making lump sum payments to another credit card.

Making the minimum payments in this situation is ok because you’re actively working to pay off your credit card debt. In any other situation, minimum only payments will prove to be expensive, time-consuming, and detrimental to your credit health.

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How Credit Card Debt Settlement Is Supposed to Work

You enroll in a debt settlement program. After you give them details about your credit card debt – which credit card companies you owe and how much you owe – the debt settlement company makes a settlement offer to your creditors. Settlement offers are usually between 10-60% of your total debt.

Ideally, the credit card company agrees to the debt settlement. The debt settlement company sends the money and you never have to worry about that particular credit card debt again.

How Debt Settlement Really Works

For a credit card debt settlement to be successful, there are a couple of prerequisites. First, you need to be able to pay the settlement as soon as the credit card company agrees. Second, you need to be behind on your payments (more on that later).

Depending on the size of your debt, even settling for pennies on the dollar could mean you owe thousands of dollars. If you had that kind of money available, you probably wouldn’t be using debt settlement. The debt settlement company helps you save up to make a settlement offer. Your payments are put into an account until you’ve accumulated enough to approach the credit card company with a settlement offer. The process is repeated for each credit card.

Unfortunately, your payments don’t accumulate as quickly as you’d think. That’s because the debt settlement company takes its fee from the first few payments. So, it could take a few months before your debt settlement savings starts to build.

Debt Settlement Hurts Your Credit Score

Credit card companies rarely (if ever) accept settlement offers on current accounts. Instead, the older your account, the more likely it is that your credit card company accept a settlement. If your accounts are currently all paid up, your debt settlement company will advise you to stop paying your credit cards so they become delinquent.

Each month you miss a credit card payment, it’s included on your credit report. Because your payment history is the most important factor influencing your credit score, those late payments missed payments make your credit score drop.

Missed payments aren’t the only part of debt settlement that hurts your credit score. If you manage to stick with debt settlement long enough to actually settle a debt, the account status will be listed as “Settled” on your credit report. That negative payment status indicates you didn’t fulfill your original payment agreement and will remain on your credit report for seven years.

Collection Calls Will Start

As your account becomes delinquent, you may begin receiving calls from your credit card company demanding payment. When your credit card goes six months past due, it will be charged-off and sent to a collection agency. You still owe the debt and your credit card company will continue to try to get you to pay.

You Could Be Sued

When you fall behind on your credit card payments, your creditor is within its rights to sue you for the debt. Telling your creditor that you’re working with a debt settlement company can speed up the process. A lawsuit could force you to pay the debt in full. If you can’t afford payment, the court may allow the creditor to garnish your wages.

Your Income Taxes May Increase

You may owe income taxes on a debt that’s been settled. The Internal Revenue Service (IRS) requires you to include cancelled debt as taxable income on your income tax return. If the cancelled debt as $600 or more, your credit card issuer is required to send you a Form 1099-C that lists the amount of debt that’s been cancelled. This form has also been sent to the IRS, so they’re aware that you should report this debt on your tax return.

The cancelled debt could decrease the amount of your tax refund if you’re due one. Worse, you could end up having to pay more taxes to the IRS.

Credit Card Debt Settlement May Not Work

In the end, debt settlement may not even work for you. There’s no guarantee that your creditors will accept a settlement offer. Actually, it could take up to a year or two before you have enough money in your settlement account to settle your first debt. After sending payments for months and seeing no results, a lot of people give up on debt settlement services.

Is Credit Card Debt Settlement Ever Right?

There may be some exceptional circumstances that make debt settlement right for you. For example, if your debts are unsecured, already charged off, and you can’t file Chapter 7 bankruptcy because you make too much money, debt settlement may be an alternative to Chapter 13 bankruptcy which requires to pay all or some of your debt within 5 years.

If you decide to settle your debts, it may be cheaper to work directly with your credit card company rather than hire a debt settlement firm and pay their hefty fees.

Related posts:

1. 8 Signs You Have Too Much Credit Card Debt
2. 7 Reasons to Pay Off Credit Card Debt
3. Dealing With Credit Card Debt Collectors

While there isn’t an obvious, in-your-face type of way to tell whether you have too much credit card debt, there are some signs to let you know it’s time to change your credit card spending habits. Think about how you’re currently using your credit cards as you read through this list. If any of these things apply, you may be in trouble with credit card debt.

1. Your debt-to-income ratio is high.

Numbers don’t lie. Your debt-to-income ratio indicates the amount of your monthly income that goes toward credit card debt payments. To figure out your debt-to-income ratio add up the amount you spend each month on credit card payments and divide it by your monthly income. If the number is above 10%, then you have too much credit card debt.

2. You always make the minimum credit card payment.

Making the minimum payment lengthens the amount of time it takes to pay off your credit card debt. Not only that, it increases the amount of interest you ultimately pay. If you can only afford to pay the minimum amount due on your credit cards, then you have too much credit card debt. To raise your monthly payment amount, you’ll have to cut back in other places. That way, you can afford to pay off your credit cards and get rid of credit card debt.

3. You frequently use balance transfers to avoid making credit card payments.

Balance transfers are a good way to take advantage of better credit card terms, like a lower interest rate. However, they’re not designed to help you skip out on your credit card payments. If you’re transferring credit card balances to keep from having to make a payment on your credit card, you probably have too much debt. And if you don’t already have more debt than you can handle, you will soon as the balance transfer fees make your credit card balances go up

4. One or more of your credit cards is maxed out.

Maxing out your credit card happens when you charge your credit to the maximum credit card limit. This is never a good idea because it hurts your credit score. Not only that, maxed out credit card balances are more difficult to repay. Several maxed out credit cards are surely a sign that you have too much credit card debt. The only good thing about a maxed out credit card is that your balance can’t go any higher, so you won’t continue to loan yourself with more debt than you can handle.

5. You’ve been turned down a loan because your credit card balances are too high.

Banks don’t want to loan money to you if you have too much credit card debt because, chances are, you won’t be able to repay what you’ve borrowed. The bank may not immediately tell you you’ve been turned down because you have too much credit card debt. Instead, they’re required to send you a letter letting you know the reason you’ve been turned down. If the letter indicates you were denied because your credit card balances are too high, there you have it.

6. You don’t know how much credit card debt you have.

As their credit card balances rise out of control, many people go into denial about how much credit card debt they have. If you avoid adding up your credit card balances because you’re afraid of the truth, there’s a good chance you have more credit card debt than you can handle. But, when it comes to credit card debt, ignorance is not bliss. The sooner you face your true credit card debt, the better.

7. You can’t afford to pay your balance in full every month.

The best way to avoid credit card debt is to pay off your credit card balances every month. That way, you never have to deal with credit card debt. If your balances are too high to pay off every month, you have too much credit card debt. When you make credit card purchases, remember to keep them at a level that you can easily repay when your credit card statement that comes. That way, you avoid the lingering balance that can become credit card debt.

8. You lie to friends, family, and your spouse about how much you’re spending with your credit cards.

People with credit card debt not only lie to themselves, they also lie to the people around them about how much credit card debt they have. If you find yourself taking extreme measures to keep people from finding out about your credit card habits, you may have too much credit card debt.

Facing Your Credit Card Debt

The first step to dealing with credit card debt is acknowledging that you have it. Sit down and add up your credit card balances, so you know how much debt you actually have. Then, make the decision to stop using your credit cards. That way your credit card debt won’t keep going up. Finally, start paying back your credit card debt. You may have to reduce your spending in other areas, but it’s worth it if it means you’ll finally be rid of credit card debt.

Related posts:

1. 7 Reasons to Pay Off Credit Card Debt
2. The Harsh Truth About Credit Card Debt Settlement
3. 10 Ways to Avoid Credit Card Debt