Charge-Off Versus Bankruptcy

Man with empty pockets
Rebuild your credit.

If you are dealing with debt, and are wondering which is better - charge-off versus bankruptcy - it's important to remember that a charge-off and a bankruptcy both have negative effects on your credit report. Both charge-offs and bankruptcies can hinder your credit and each one tells potential creditors something different.

Charge-Off Versus Bankruptcy: Key Differences

If you are faced with debt, it might be tempting to think that it's easier to let your creditor charge-off your debt. After all, a charge-off does not stay on your credit report as long as a bankruptcy does. However, allowing your creditors to charge-off your debt might not be the easy answer you're looking for. There are a few key differences between a charge-off and a bankruptcy, although both will have a negative effect on your credit report.

What Is a Charge-Off

If you fail to make at least the minimum payment to your creditor for six months or more, the creditor may choose to charge-off your account. When a creditor charges-off your account, the creditor is essentially declaring your account as a loss. The charge-off does go on your credit report and will stay on your credit report for seven years unless you can somehow negotiate to have it taken off.

Perhaps the most important thing to know about charge-offs is that a charge-off does not absolve you from the debt that you owe. You still have to resolve the issue with the creditor. If you pay your debt, the creditor may change the status on your credit report from charge-off, to "charge-off paid" or "charge-off settled." While all three have negative connotations, having a charge-off on your credit report is by far the worst of the three. It essentially says that you are unwilling to deal with your debt.

What Is Bankruptcy

A bankruptcy is a process that a debtor chooses when he realizes that he is unable to pay his bills. When an individual or business can no longer pay their creditors, bankruptcy is an option to help them get relief from payments and debt. A debtor will file a bankruptcy typically with assistance from an attorney. Once filed, the bankruptcy courts then determine whether or not the debtor qualifies for a bankruptcy.

How a Charge-Off Affects Your Credit Rating

According to the Fair Credit Reporting Act, a charge-off can remain on a person's credit report for up to seven years. This can affect a credit report negatively and drop an individual's credit score. The amount of the drop is determined by how much is owed and how long the debtor has avoided payment. When a charge-off occurs, the creditor can freeze the line of credit and can make repeated attempts to collect the debt through phone calls or mail notifications. It can be difficult to obtain loans or credit with low annual percentage rates in the future with a charge-off listed on your credit report.

How a Bankruptcy Affects Your Credit Rating

A bankruptcy stays on your credit report anywhere from seven to ten years, depending on the type of bankruptcy filed. Your credit score will drop initially which is determined by the amount of total debt owed to creditors and the length of time the debtor held the debt. After a bankruptcy is filed, it can be very difficult to obtain more credit or loans initially. However, after the first two years of a bankruptcy filing, a debtor's credit rating will begin to rise and the debtor can find some lenders who will offer credit.

Avoid a Charge-Off

Communication is the name of the game when it comes to avoiding a charge-off. Call your creditors if you have not made payments within the last 30 days, or if you know you will not be able to make payments regularly. They can help you work out a payment plan to get your finances back on track. Consider creating a budget to find out on paper where all your money is going. Open your credit card bills and keep a detailed log of which creditor is paid and when payments were made. List the due dates for payments on a calendar to avoid late fees that can add to the principal credit amount.

Avoid Filing for Bankruptcy

Filing for bankruptcy is usually the last resort when a debtor can no longer pay his debts. Just as communication is important to avoid a charge-off, it is equally important to avoid bankruptcy. Discuss your options with creditors; they may offer a settlement plan to reduce your monthly payment or the principal amount. If you can't settle the debt, find out if you can work out a payment plan that works with your income to pay off the debt.

Manage Your Finances

Get help from a financial counselor who can help you make decisions on how to manage your debt. Deciding to do a charge-off versus bankruptcy can seem like a walk in the park when it comes to financial hassles, but both types can negatively impact your credit. Develop a plan with a counselor to attack your debt to avoid both a charge-off status and a bankruptcy.

Charge-Off Versus Bankruptcy