Your credit score is a number. Simple, right? But what goes into your credit, as well as the vernacular behind it, can be a little confusing. These intricacies, however, are the buildup of your credit, and the foundation of whether you can secure financing for that car or home.
Here’s a duo of terms we’d like to clear up: Charge-offs and collections. Although similar in that they both indicate negative credit history, you shouldn’t mix them up. Let’s break down these two terms:
Charge-Offs vs. Collections
If you’ve gone long enough without paying a debt, the loan will eventually go into default. At this point, your lender will recognize this debt as an unprofitable asset and will write off the amount owed as a business expense. This is called a charge-off.
Sometimes, the lender will sell off the debt to a third-party debt collector, or a collection agency. These accounts are known as collection accounts. Collection agencies buy the debt cheap, in hopes that the debtor will eventually pay up.
Credit Score Implications
If you’re above a 720, you can expect a charge-off or collection account to have a similar impact on your credit score, according to Linda Sherry, National-Priorities Director for Consumer Action, a consumer rights group. She says that, on average, you could see your score drop about 100 points. Of course, consumers with lower scores can anticipate a slightly lower drop, since they tend to already have more derogatory information on their reports. In other words, the bigger you are, the harder you fall.
Usually, a charged off account will be reported to the bureaus with an past-due balance, and this could have a harmful effect on your credit score. If you pay off the debt, the past-due balance is removed from your credit report.
Conversely, paying off an account that has been sent to collections does not have an impact on your credit score. Because the debt has already been sent to the collection agency, the event of a collection has been recorded by the bureaus, and isn’t listed as a balance. Therefore, paying off the collection account won’t have an effect on your score.
Of course, the best way to mitigate either of these situations is to practice credit responsibility. If you pay your bills on time, you’ll never have to learn these terms the hard way.