What does charged off as bad debt mean?

When it comes to personal finance, there's a lot to learn. Credit is an important—and sometimes confusing—topic. 

For example, you might know what a credit report is and why you have one. But you might not understand what it means when one of your accounts is marked charged-off as bad debt. 

If you've seen that phrase on your credit report, here's how to make sense of it. 

What does charged off as bad debt mean?

A charge-off on a credit report means the creditor has written a debt off as a loss. In other words, the creditor doesn't think they'll be able to collect the debt. 

Charge-offs happen when a debt goes unpaid. So, if you don't pay a credit card or if you default on a loan, it could end up as a charge-off account. 

It's up to the creditor to decide when to pull the plug on collection efforts and charge off a bad debt. A typical time frame is 90 to 180 days without payment.

Why do creditors charge off debts? The simple answer is a tax break. 

When a creditor charges off a bad debt, it comes off the company's books. The creditor could write off unpaid debts at tax time, the same way you might write off student loan interest or charitable donations to lower your tax bill. 

What charged-off as bad debt doesn't mean

If you see that one of your debt accounts has been charged off, it doesn't mean the debt no longer exists. It’s a debt you still owe. 

The original creditor could assign or sell the debt to a debt collection agency. The debt collector could then reach out to you to get you to pay up. 

You might get phone calls or emails with requests for payment. If those go unanswered or you file a cease and desist letter to request they stop contacting you, the debt collector might file a lawsuit with your local court. 

When that happens, you'll get a summons that tells you when to appear in court, and you'll have a chance to respond before the court date. If the debt collector wins the case, they could take additional steps to garnish your wages or freeze your bank account. 

Charged-off debts don't go away when the statute of limitations expires, either. 

Each state has a  law that tells creditors how long they are allowed to try and collect on unpaid balances. Once the statute expires, you can no longer be sued for the debt, but legally, you still owe the balance. 

How do charge-offs affect your credit scores? 

Creditors could report charge-offs for bad debt to all three major credit bureaus: Equifax, Experian, and TransUnion. These are the agencies that collect information about your credit and add it to your credit reports. 

A charge-off could lower your credit score because it's considered a derogatory indicator. In simple terms, that means negative information. If you have a charge-off, it means you have late payments on your credit history, which could also hurt your scores. 

Does it help your credit score to pay off a charged-off account? It could, though some credit scoring models weight charge-offs differently. Keep in mind that whether you pay or not, charge-offs and other negative items could stay on your credit report for up to seven years. 

What should you do if you have a charged-off debt?

If you get a letter that says a debt you owe has been charged off or you see this listed on your credit report, it helps to know what to do next. Here's how to handle it. 

• Validate the debt. Creditors and debt collectors are required by law to validate debts in writing. You should get a debt validation letter that explains the amount owed, the original creditor's name, and your rights if you don't think the debt is yours. 

• Check your records. If you don't recognize the debt details in the validation letter, check your records. Look at your credit reports to see if the debt is listed or check your bank statements to see if you've ever made any payments to the original creditor. 

• Review the SOL. If you think a charged-off debt is outside the statute of limitations, ask the creditor or debt collector to confirm the last date that a payment was made. Check the laws in your state to see if the SOL for the debt has expired so you know whether the debt collector could still sue.

If you determine that the debt belongs to you, you'll need to think about what you want to do next. 

You could…

• Do nothing—but that doesn't eliminate your responsibility for the debt. 

• Pay the debt in full, if it's doable for your budget. 

• Work out a payment plan with your creditor or debt collector. 

• File for bankruptcy protection to erase the debt. 

• Negotiate the debt to pay less than what you owe. 

You might talk to a debt expert about which option makes the most sense. A debt expert could look at what you owe and your financial situation to offer solutions. 

For some people, bankruptcy is the best way out of debt. For others, it's better to resolve the debt and pay a reduced amount. The rest of the debt is forgiven, and it usually isn't taxable if you prove insolvency, meaning you have more debt than assets. 

And you could also think about how to avoid charge-offs in the future. 

If you don't have a personal budget in place, for example, you might want to sit down and make one so you know where your money goes. You could also set up calendar notifications or enroll in automatic payments so you never miss a due date. These are small steps, but they could pay off in a big way if they help you improve your financial health.