There are many terms in the world of personal finance, some of which might apply to you but you might not have heard of. The more you understand about these terms, especially when you're reviewing your credit report, the more empowered you can be to work on your credit. One of those is the term "charge-off." Read on to learn more about what it may mean if you see one on your credit reports.

What is a charge-off? 

"Charge-off" generally refers to an account that has been closed by the original creditor due to long-standing delinquency. Accounts may become charged-off when they remain unpaid for a certain amount of time and the lender reacts by closing the account and taking it off their books.

Just because an account was charged-off (and labeled that way) doesn't necessarily mean the borrower doesn't owe, however. Technically, charged off debts can still be a debt the borrower may have  to pay back, although the lender might choose to sell the debt to a collection agency. At that point, the borrower will owe the collection agency (who now owns the debt) and not the original creditor.

A charged-off account, when reported, should show up on your credit reports as such, and it may show up twice if a collection agency buys it. In other words, the original creditor charge-off could be on your credit reports, as could the new account opened by the collection agency. According to Experian, though, both should fall off your credit reports seven years after the original delinquency date.

What a charge-off means for your credit.

A charge-off can harm your credit. It's generally viewed as a negative item that can live on your credit reports for seven years even if you pay it off. If you do it pay it off, the status should change.

For example, if you pay the charge-off balance with the original lender before it gets sold to collections, the status should change to "Paid Charge off." If you pay it off while it's in collections, the status should change to "paid collection." It helps to show you've paid off the account, but it's important to remember that it likely won't result in an automatic removal of it from your credit reports.

It's also important to know that having this or other negative items on your credit report doesn't mean your credit can never recover. According to VantageScore, the potency of negative items can decrease over time. In their words, "The impact that negative information will have on your credit score may diminish over time because your credit history is weighted less as it ages." 

Similar language can be found on myFICO, which says that credit scores change "as new information is added to your bank and credit bureau files." The credit scoring company goes on to say that, "scores change gradually as you change the way you handle credit," and "past credit problems impact your scores less as time passes."

In other words, having a charge-off on your credit reports can damage your credit scores, but time and better credit behavior can turn the ship around. 

Being proactive on charge-offs.

Combine the fact that the negative effect of a charge-off can decrease over time with the action and knowledge that you can improve your credit with simple steps such as paying off a charge-off and paying all your other bills on time. Then hopefully it'll be clear that a charge-off doesn't have to mean the end of the world for your credit. The sooner you take action, the sooner you can start to bring your credit into a positive state.

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