“My Debt is a Charge-off. Do I Still Need to Pay It?”
It’s time for me to bust another common debt-related myth that I get asked about frequently. Basically, the myth is that once a creditor records a “charge-off” when your account is declared a bad debt and a loss is recorded by the creditor, then the creditor no longer has a right to attempt further collection on that written-off debt.
Here’s a quote from a bogus “debt elimination” website that pretends to be a valid source for consumer education in financial matters: “They cannot collect one penny,” the website says. “If you see charge-off on the account they are trying to collect on your credit report it is illegal for these debt collectors to collect one penny. The original creditor took the bad debt as a loss when they filed their income tax and got a credit benefit from the IRS.”
What a load of horse manure! Folks, this statement is Completely 100% FALSE. Aside from the fact there are millions of debt collection lawsuits/judgments that prove otherwise, this ridiculous pronouncement does not even make sense from an accounting perspective.
When a creditor records a charge-off, they are forced to “write off” the uncollected balance, usually after 180 days of delinquency. Naturally, this translates to less income, which lowers the corporate tax owed for that year. Even on this point, the website gets it wrong, because this is not a “credit benefit from the IRS,” but rather a lower tax bill because the company made less money to be taxed on.
OK, so far so good. But let’s say the creditor is successful through the collection process and recovers 50% of the balance that was written off. What happens next? Simple. The recovered amount is recorded as an ADJUSTMENT on a separate part of their bookkeeping ledger, usually in a section called “Allowance for Loan Losses.”
Here is a direct quote from the official corporate Form 10-K filed with the Securities and Exchange Commission by one of the world’s largest credit card banks:
“Allowance for loan losses represents management’s estimate of probable losses inherent in the portfolio. Attribution of the allowance is made for analytical purposes only, and the entire allowance is available to absorb probable credit losses inherent in the overall portfolio. Additions to the allowance are made through the provision for credit losses. Credit losses are deducted from the allowance, and subsequent recoveries are added.”
There you have it, straight from the horse’s mouth. The allowance account is the amount reserved for estimated losses against loans made. When the company record a charge-off loss, it must be deducted from that allowance account. The important bit is that “subsequent recoveries are added” to the allowance account. In other words, in plain English, “it all comes out in the wash.” The recovered funds are simply accounted for separately. And that *new* income is properly taken into account, offsetting a portion of the loss previously declared.
So what does all this mean to you if you have a charge-off account? It’s very important you understand that a charge-off does NOT relieve you of your legal obligation to repay the debt. You are still on the hook to pay that debt (or settle it). This fact is well-known to anyone who has spent more than a few days working in the debt/credit industry on EITHER side of the fence. Only an absolutely CLUELESS amateur – or a deceitful con-artist peddling a bogus “debt elimination” program – would claim otherwise. Yet if you go to your favorite search engine and type in “debt elimination,” you will quickly find dozens of websites that make this absurd claim.
Don’t buy into this nonsense and ignore charge-off accounts just because you read on some website that you’re no longer responsible. It’s vitally important that you (a) understand the status of your debt accounts, and (b) work toward achieving a resolution on those accounts. Otherwise, you might just face a lawsuit that turns into a judgment, which could lead to a wage garnishment or a lien on your property.