Your Complete Guide to Dealing With Collections and Charge-Offs on Your Credit Report

There are five categories of information that make up your FICO® Score. None is more important than your payment history, which accounts for 35% of the total. The most obvious piece of this category is whether you pay your bills on time or not, and for people with strong credit histories, it usually ends there.

On the other hand, if you're one of the millions of Americans without a spotless credit history, some other things could be weighing down your credit score in the payment history category. Two big ones are collection accounts and charge-offs. These can be score-killers and can linger on your credit for years, especially if you don't know how to deal with them.

With that in mind, here's a guide to dealing with collections and charge-offs on your credit. To be clear, these aren't easy to get rid of, but they're definitely worth confronting head-on. With smart planning you can put yourself in a position to deal with them wisely and help accelerate your credit-repair process.

What is a collection account?

A collection account is what happens when a creditor has unsuccessfully tried to collect a debt from you for some time. Accounts usually don't go to collections until they are three to six months old. In this case, what generally happens is the creditor sells your debt to a collection agency for pennies on the dollar. Then the collection agency assumes responsibility for collecting the debt. You get a collection letter and a big ding on your credit score.

What is a charge-off?

Charge-offs tend to be worse than collections from a credit repair standpoint for one simple reason. You generally have far less negotiating power when it comes to getting them removed.

A charge-off occurs when you fail to make the payments on a debt for a prolonged amount of time and the creditor gives up. The creditor then writes off the debt as a loss. This generally happens after about six months or so of non-payment, but it varies among creditors. After your debt is charged off, the creditor can continue to try to collect the debt, or they may decide to sue you for it. In many cases, the creditor will sell your debt to a third-party collection agency.

How to determine if you have collections or charge-offs on your credit report

Before you can start to rebuild your credit, you'll need to assess the damage and gather some information that will help you deal with it. To do that, you'll need a copy of your credit reports.

Notice that the word "reports" is plural. There are three major credit bureaus that maintain files on American consumers -- Equifax, Experian, and TransUnion. While all three should theoretically contain the same information, in practice they are rarely exactly the same. In short, you need all three to do the best job of assessing your damage.

Fortunately, the law entitles you to a free copy of your credit report from each bureau once per year. There are many "free credit report" websites out there, but these generally don't give you all three reports and are designed to sell you some sort of service. Plus, they will often end up spamming you with emails if you sign up.

The place to claim your truly free credit reports is at www.annualcreditreport.com. You have the option of requesting just one, or all three of your credit reports. For the purposes of damage control, it's a good idea to request all three. If you come to a screen requesting your credit card number, click away and start over. There is no fee or credit card number required for your free annual credit reports.

Unfortunately, there is no federal law that entitles you to a free credit score. Nonetheless, you'll be able to get one easily. Take a look at our brief guide on how to get your credit score to learn more about this.

How long do collections stay on your credit report?

Collections and charge-offs stay on your credit report for seven years. The clock starts on the date of delinquency. When the collection or charged-off account first appears in your credit file, your score will take a big hit. The better your score was, the bigger the hit will be. If the creditor has already been reporting late payments on the account for several months, your score might not be hurt much more when the account is converted to a collection account or reported as charged off.

The damage to your credit score diminishes over time, especially after the first two years. At that point, the negative account will have a smaller and smaller effect on your score.

Beware of this "credit repair" strategy when it comes to collections and charge-offs

There are many so-called "credit repair" companies that coach you to raise your credit score by abusing the dispute process. In a nutshell, they instruct you to (or the service will) send letters to the three major credit bureaus disputing the legitimacy of every negative item on your credit report -- late payments, collections, charge-offs, judgments, you name it.

By law, creditors must verify the accuracy of disputed information within 30 days, or the credit bureau must remove it from your credit report.

Creditors often don't verify the information within the 30-day window. The negative data is indeed removed, resulting in a credit score bump -- at least temporarily. However, there are some key problems with this strategy:

• It doesn't always work. If you have lots of negative information on your credit report, it's likely that some of the creditors will verify the account on time. Many creditors are aware of this technique and do everything in their power to keep negative information on your report for as long as possible, especially if you owe a balance so you are incentivized to pay it.
• The negative item can come back. Just because a creditor doesn't verify an item within 30 days and it gets removed doesn't mean it's gone for good. In most cases, a creditor can report a negative item for up to seven years from your first delinquency, even if the item was previously removed. So, many people find that their credit score increases significantly at first, only to fall again as the accounts reappear.
• It can backfire. For instance, let's say that a creditor reports an account as delinquent, but doesn't update their information often. By legally forcing them to verify it, they'll also update their files. If one of your accounts is really a charge-off, but was still being reported as 60 days late, confirmation could actually have a negative effect.

If you see collections or charge-offs that are incorrect or don't belong to you

While I'm not a fan of using the dispute process to try and game the system, I encourage you to use it for its intended purposes.

Here's when to file a dispute:

• You notice collection accounts or charge-offs that don't belong to you
• Balances or charge-offs on your report have already been paid
• Items on your report contain some other erroneous information

To be clear, erroneous data is a widespread problem. A study by the Federal Trade Commission found that about 20% of credit reports contained legitimate errors. On top of that, about 5% of all credit reports contained errors that were so significant that, when removed, they resulted in the consumer's credit score increasing to the point where they could get a lower interest rate on loans.

The easiest way to dispute credit report errors is to click through the dispute process while viewing your credit report online. If you prefer, you can mail a dispute letter. You'll find instructions for how to do that when you view your credit report.

Dealing with legitimate collections and charge-offs

Now that we've looked at how to handle incorrect information, let's take a look at how to deal with collection accounts and charge-offs that are accurate. There are a few things you should know before you try to resolve a legitimate debt. We'll start with collection accounts.

How collection agencies acquire your debts

It's important to note that debt collectors buy debt for pennies on the dollar. When an original credit account is very delinquent, it's viewed as unlikely to ever be paid. This type of debt is typically sold to a collection agent at a steep discount.

For example, say a debt buyer pays just $0.04 for every dollar of a debt's face value. If that debt was $5,000, a debt collector would pay around $200 for it.

Because the debt collector paid so little to buy someone's debt in this scenario, there would be significant room to negotiate a settlement. It's not uncommon for a $1,000 collections account to be settled for $300 or so, for example.

Several possible outcomes

One extremely important point to consider when dealing with collectors is the status that will be displayed on your credit report after the delinquent debt is cleared. The status can have a significant impact on your credit score. While this is a bit of a simplification, there are four general statuses that can be given to collection accounts on your credit report:

• Unpaid: You still owe money.
• Settled for less than the original balance: You don't owe anything but didn't repay your debt in full. This is a negative in the eyes of prospective creditors.
• Paid in full: This is a more favorable outcome and is likely to help your credit score more than a "settled" designation.
• Removed: This is where the collection account is no longer listed on your credit report at all. It's the Holy Grail outcome of paying off a collection account.

Note: In a recent version of the FICO formula (FICO® Score 9), paid collections are no longer counted as a negative score factor. (They'll still be listed on your credit report.) However, it's important to realize that although FICO® Score 9 is several years old, not all lenders have started using it yet. Paid collections are still a negative factor in the most commonly-used version (FICO® Score 8). Paid collections don't hurt you as much as unpaid collections.

Negotiating with collection agencies

The wording used on your credit report, as discussed in the last section, can certainly be a factor in the negotiation process. For example, if a debt collection agency offers you a settlement in writing, you can call them and say that you'll write them a check right now if they'll agree to permanently remove the account from your credit afterward.

If they say no, ask if they'll at least report it as "paid in full" instead of "settled."

You can often successfully negotiate a removal by offering to pay the debt in full -- as this would be a win-win for both you and the collection agency.

In my experience, most collectors will jump at the chance for a quick payday. After all, once they get their money, what do they care what your credit report says? Just be sure to get the agreement in writing before paying the account. (This is generally a good idea anytime a creditor or collector agrees to anything.)

Get it in writing

Piggybacking on the last section, I can't over-emphasize the importance of getting any offers, concessions, or promises from creditors in written form.

For example, don't take a debt collector's word that they'll remove a negative item from your credit report completely if you pay the balance in full. Insist that you have the offer in writing before you send them any money. This is a pretty standard procedure, and any collector should be used to accommodating requests for written communications.

Know your rights when dealing with collectors

One important thing to keep in mind before you start calling debt collectors, or before you answer their phone calls, know your rights as a consumer. The Fair Debt Collection Practices Act (FDCPA) protects you from abusive debt collection practices. However that doesn't mean that all collectors actually follow the rules.

With that in mind, here's what debt collectors are not allowed to do:

• Talk about your debts to anyone except you or your attorney. They are, however, allowed to call friends or family members (once) for the purposes of finding out how to get in touch with you.
• Harass you. They can't keep making debt collection calls repeatedly and can't use foul language when speaking with you.
• Keep calling if you request they stop. You can submit a request in writing to ask them to stop making collection calls. If you do that, they can only contact you to say that they'll be stopping collection efforts or taking legal action against you. This is my preference, as it's easier to deal with collectors in writing -- plus having written records helps protect you.
• Make any claims that they can't legally follow through on. They can't threaten to have you arrested for not paying, or foreclose on your house.
• Lie about who they are or the purpose for their contact. Before the FDCPA, it was common practice for a collector to call pretending to be an old friend just to get you on the phone. A legitimate debt collector will not do this today.

What's more, debt collectors are required to tell you (in writing) within five days of their initial contact with you that you have the right to dispute the debt. In addition, you have the right to ask for a debt validation letter proving that the debt is yours. And you have the right to ask for (and receive) the name and address of the original creditor.

How should you deal with a charge-off?

Your best strategy depends on which course of action the creditor uses to try to get some of its money back.

If the creditor has not yet sold your debt to a collector or tried to sue you, you can negotiate a settlement in the same manner that I discussed in the section about dealing with collection accounts. Generally, this is the case for the first three to six months after your account became delinquent, although the timetable can certainly be longer or shorter than this.

On the other hand, if the creditor sues you for the debt or sells it to a third-party debt collector, it gets a little more complicated. To be clear, either of these situations will likely result in two negative items on your credit report -- the original charged-off account as well as the resulting collection account or legal judgement. (Note: Collections accounts are far more common than judgments when it comes to unpaid credit card debts, although it's not unheard of for a credit card company to sue to collect a debt, especially if it's a large dollar amount.)

You'll probably need to deal with the collection and charge-off individually, especially if the debt has been sold to a third-party collector. A debt collector has no control over what the original creditor reports to the credit bureaus. Plus, the original creditor has no incentive to help you out simply because you paid off the debt collector.

If your goal is to get a charge-off removed and the debt has been sent to a collector, the only way to do it is to negotiate with your original creditor. That's the one reporting the charge-off. If you aren't sure how to get in touch with the original creditor, you can find their contact information attached to their entry on your credit report. As soon as your call is answered, ask to speak to someone who has the authority to remove the charge-off.

Strategies for dealing with charge-offs

One strategy that many people have had success with is asking the creditor to remove the charge-off (or simply to stop reporting it) in exchange for some sort of payment. You don't need to offer your account's full balance -- after all, even if the creditor accepts your debt settlement offer, you still legally owe the entire debt to a third party. But, the more you are prepared to pay, the better position you'll be in to negotiate.

As always, get any promises to delete the charge-off in writing. Ask the person you're speaking with to mail the agreement on a company letterhead and don't send any money until you have the document in your hand.

You can send a removal request in writing. This is known as a pay-for-delete letter in which you state that you're willing to pay a certain sum of money in exchange for removal of the charge-off.

Here's one point to remember. The creditor you're dealing with is a business. At the end of the day, they really don't care about your life story or any excuses (valid or not) about why you didn't pay the debt. If it makes good business sense for them to stop reporting the charge-off, they're likely to do it. Be polite and keep the conversation or letter to the point you want them to know -- that it's in their best interest to accept your offer of payment for removal.

Alternatively, there are legitimate credit repair professionals that will negotiate with creditors on your behalf. Some attorneys specialize in credit repair and debt repayment issues, for example. Just be prepared to pay handsomely if you pursue that route.

A lower budget debt relief option is to seek help from a certified credit counselor. Credit counseling is especially appropriate if your collections and charge-offs are part of a larger unpaid debt problem. Start by visiting the National Foundation for Credit Counseling at NFCC.org, and use their website to find a certified counselor in your area. If you are eligible to enter into a debt management plan, the counselor will negotiate with creditors on your behalf. There may be a monthly fee to work with a credit counselor, but it can be low, or even waived if you qualify.

What if the original creditor won't budge?

Unfortunately, charge-offs cannot be removed in every situation. The worst-case scenario is that a charge-off remains on your credit report for seven years from the date the account first became delinquent.

Since negative information matters less as it ages, don't give up if you can't successfully have all of your charge-offs eliminated. I can tell you firsthand that it's possible to build a decent credit score even if you have old debt on your credit report. In fact, when I was in the process of repairing my own credit years ago, my FICO® Score reached 700 -- about average credit -- before my last outstanding debt dropped off.

Don't get discouraged

As a final thought, while the process of dealing with collectors and charge-offs can be lengthy and downright frustrating at times, don't get discouraged. It'll feel great to start seeing the results of your efforts in the form of a gradually-rising credit score -- I know from experience.

After destroying my own credit in college nearly 20 years ago, I went through this process myself. Not only did I learn the ins and outs of doing damage control on a credit report, but I also gained an appreciation for good credit behavior and using the FICO methodology to my advantage. These days, I'm well in the realm of excellent credit, and I feel that it's because I learned the hard way.

In short -- learn from your mistakes. Strong credit can literally save you a fortune in interest charges over your lifetime and can allow you to take financial steps that may otherwise be impossible. The road to effective and lasting credit repair is a marathon, not a sprint. Do it right, and you'll be glad you did.