Investopedia primer on charged-off debt.

Charged-off debt is a term you don't want to hear, but unfortunately, it happens to millions of Americans yearly. So what exactly is charged-off debt? What to do when you have it, and how can you avoid it?

Charged-off debt occurs when a creditor decides you are unlikely to repay what you owe them. This can happen for various reasons, but you have missed several payments for 90 days or more, although it's usually 180 days or more before a charge-off occurs. Once your debt has been charged-off, it will show up as "charged-off" on your credit report, significantly damaging your credit score. This is because the missed payments in your repayment history and the credit account closure impact core factors in your credit score.

A charged-off account does not eliminate your obligation to pay; your debt is now being pursued by a debt collector, either on a contingency or sold outright, to collect on your debt. Debt collectors must notify you in writing their intent to collect on your debt and include:

• The debt amount ($);

• The creditor’s name;

• Any associated fees or payments since charge-off; and

• A statement informing you that if they do not dispute the validity of the debt within 30 days that it will be assumed to be valid.

If this debt is inaccurate or you have questions about its validity, it's critical to respond within 30 days. If a debt collector doesn’t give you information to validate the debt, it could be fraud, so report them to the FTC at ReportFraud.ftc.gov. To learn more about your rights, visit consumer.gov/debt. 

Debt collectors work primarily on commission, so if you reach out to them, their sole goal is to get you to pay the most significant amount of money in the shortest amount of time. Some will offer you a settlement for making a lump sum payment immediately. Payment plans are options, but likely not for much less than you owe and over a shorter period than what may work for you. You can try to negotiate, but know that they likely won't give you much leeway unless you pay a lump sum of money.

Several law firms engage in debt collection. It is crucial to respond if one of these firms reaches out because they will sue you in civil court. Debt lawsuits have soared in the courts, representing 25% of all cases in civil courts. If you get sued, you can typically contact the law firm to work out a payment plan to halt litigation. You will be required to sign a legal agreement to repay the debt and some legal fees for them to dismiss the suit. Not honoring the agreement can lead to a default judgment. Similarly, not responding to a debt lawsuit summons within 30 days can lead to a default legal judgment. These judgments include garnishment of wages, property liens, and in extreme cases, imprisonment for failure to respond to a court summons.

If you pay your charged-off debt, your credit report will reflect it, either paid in full or at a settlement. There's a debate about whether it's better to pay in full or at a settlement since the way credit scores are factored, it's a negligible difference. However, paying a settlement can lead to issuing a 1099-C, an IRS form declaring any debt forgiven of $600 or more is income. Finally, while paying the charge-off has a benefit over time, it does not rebound your credit score.

There are a few ways to avoid being charged off in the first place. First, make sure you keep up with your payments. This seems common sense, but many people forget or simply can't keep up with their monthly payments. If you find yourself in this situation, reach out to your creditors as soon as possible and explain the situation. If you stay in communication with your creditors, they are less likely to send your debt to an outside collection agency, and they will work with you, particularly if your economic situation has changed for the worst.

If you are already in debt and struggling to keep up with your payments, consider contacting a reputable credit counseling agency or a debt management company. They can help you develop a plan to get out of debt and improve your financial situation. Additionally, some companies offer debt consolidation loans, which could be a path forward, assuming you can get approved for the loan.

Charged off debt can be scary, but if you are proactive and take action, you can avoid it. Just remember to make all your payments on time, talk to your creditors if you are having trouble, and consider credit counseling if you are already in debt. You can get back on track financially with an intentional effort!