Bankruptcy discharge or “charge off?” What’s the difference?

Discharge?  Charge-off?  The two words look a lot alike.  Do they mean the same thing?

Nope.  Discharge is a magic word.   A legal word, anyway.  At the end of your bankruptcy case, you get a bankruptcy discharge.

The bankruptcy discharge is a court order that the people you owed money to cannot do anything to collect those debts from you.

A discharge is an order to your creditors from the bankruptcy judge that they cannot do anything to collect the debts from you.

(If the debts are attached to your house or car, they can still go after the property; but they cannot go after you.)

The purpose of the bankruptcy discharge is to help you get a new start.

“Charge-off” is an accounting term.  It’s an accounting term that also shows up on your credit report.  Charge-off means you are probably not going to send in next month’s payment.

Why is that important?  A “charge off” is very important to the bank.  The Federal Reserve keeps close track of charge offs.  The Federal Reserve (and other regulators) wants to be sure that each bank has enough money to cash checks that people might bring to the bank each day.  When it comes to figuring that out, probably the next payment on your charged off debt won’t be there.  The Federal Reserve will close banks that can’t cover their checks, so the bank better make sure some other money is there since yours won’t be.

How is the charge off important to you?  The bank or credit card company puts a “charge-off” on your credit report.  Having a charge off on your credit is a “major derogatory.”  Major derogatory are the worst things you can have on your credit report.  Plus, you still owe the money!

When is a debt charged off?  Federal Reserve regulations require that credit cards be charged off when they are 180 days late.  Car loans and installment loans charge off when they are 120 days late.  (When they figure whether a bank will have enough money next month, they are allowed to hope that your next payment will be there, if you are only 90 days late.  They do not expect you’ll start paying again if you are 180 days late.)

What happens after a charge off?  Sometimes they send it to a lawyer to sue you.  (In Virginia, if it’s less than $15,000, you get sued on a warrant-in-debt.)

Sometimes it goes to a debt collector.  A debt collector will send you a letter, and call you day and night to make a payment.  They will also show up on your credit report as a “collection account.”

A collection, like a charge off or bankruptcy, is a major derogatory that is very bad for your credit.  It’s worse than a bankruptcy, because it keeps piling on.  That charge off, from your original creditor–like Bank of America–has now been joined by a “collection account.”  Your same debt now shows up as two major derogatories–first the charge off, then the collection account.  Later on, if they sue you, then you get a judgment.  That would be your third major derogatory on the same debt.

Besides all this damage to your credit report, you still owe the money.  There’s a whole industry–debt collectors, debt buyers, collection lawyers, who make their living collecting charged off debts.

Credit bureaus are part of the debt collection industry in two ways.  First, although they like to deny it, credit bureaus are used by creditors to pressure you to pay.  Creditors set up credit bureaus as a way to pressure people to pay.

Second, the credit bureaus  alert the collection agencies when charged off debts have a chance of being paid.  Debt collectors can subscribe to email alerts, so they are notified when they have a good chance to collect charged off debt.

How does that work?  Suppose Chuck has been out of work for over a year, and five credit cards have bee charged off and gone to collection. After he told them each ten times that he was out of work and could not pay, Chuck was lucky and they left him alone.

Now Chuck is working again.  He looks at his credit report and decides to try to settle up on his charge offs, one at a time, starting with the smallest.

Boom!  As soon as he settles the smallest one, the phone starts ringing off the hook, with calls about the other four–each trying to be meaner than the other.

When that first settlement hit his credit report, the bureaus sent an email to all Chuck’s creditors, telling them to come and get it.  Pay off one creditor and they all jump on.

How does it all add up?  If you have a charge off, that’s a major derogatory on your credit report.  Theres a whole industry that tries to collect charged off debt.  Each step can put another major derogatory on your credit report.  Charge off does not protect you from any of that.