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   ARTICLE   |   From Scotsman Guide Residential Edition   |   May 2016

Old Debts Rarely Fade Away

Fixing bad credit requires diligence, patience and a good paper trail

It is never a good idea to purposely avoid paying your debts. Unfortunately, many consumers who have come across hard times do just that. Ignoring debts or hoping they will magically go away, however, can come back to bite you big time, particularly for consumers who hope to obtain a mortgage.

In the language of credit, one of the more misunderstood terms is the phrase “charge-off.” For the consumer and banking professionals alike, it can conjure up the wrong assumption that the outstanding debt balance has been paid off and eliminated.

What happens when consumers avoid paying their debts can be both bad and ugly — but not hopeless. As a mortgage originator who knows what to keep an eye on, there is usually some opportunity to turn your borrowers’ bad situation into a good outcome.

Charge-offs

After six to 12 months of trying to collect money owed on a debt with no results, the original creditor normally classifies the account as a charge-off. That’s essentially a company’s process of writing off an expected customer payment that was once considered an asset but has since become worthless.

Charge-offs have a major impact on individuals’ credit scores, and that can affect their future ability to secure a loan, particularly a home mortgage. Consequently, loan originators should pay attention to a potential client’s credit score — and seek out ways to shore it up if necessary and possible.

Late payments also have a negative impact on credit scores and, if left unaddressed, will eventually turn into charge-offs — making the entire credit-report entry look like a negative account. Frequently, original creditors will sell charged-off accounts to a collection agency for pennies on the dollar.

When that happens, the collection agency will report the account to a credit bureau as a new negative entry, which will drop consumers’ credit scores even lower. Not only will the original negative credit notation appear on the credit reports, but an additional notation will be made by the collection agency. Both are registered and represent a double whammy on the same account.

Additionally, a negative notation of a charge-off does not mean the debt incurred has been forgiven by the creditor. The debt still exists. It could remain on a credit report for seven years from the date of the first negative notation. Creditors still have the right to collect the full amount of the debt in a number of different ways.

Many clients do not understand that even if you dispute an account on a credit report, and it is deleted, the debt still lingers in the debt-collection world. In addition, adding to the confusion, many clients don’t realize that the length of time a negative account can stay on a credit report has nothing to do with the legal statute of limitations that defines the time frame for creditors to pursue recovery of a debt through the courts.

Deletions

There is no simple or quick fix for resolving credit issues. Even if you contact the collection agency and pay off the debt, that doesn’t remove the negative item from the credit report or guarantee your credit score will go up.

A pay-to-delete strategy commonly used by collection agencies suggests that if an individual pays the agency as much as possible, if not all the debt owed, the agency will then lobby the credit bureau to delete delinquent items from the consumer’s credit report. If a settlement with the creditor achieves a deletion of the account, then that is the best-case scenario.

If that’s not possible, deletion of the charge-off notation and having “closed” or “paid” noted on the credit report is the next-best scenario. Those terms indicate a “final status,” meaning the account is no longer active and should not be pursued again. Originators should ensure that clients keep documentation because, on occasion, old paid-off debt has been sold accidentally, and then the agonizing process of dealing with it begins again.

Payoffs

Even paying off an old debt can have negative consequences. It can actually be counterproductive in some cases. Payments made on such debts will update the report date on the credit file. If there has been no reporting activity on that debt, paying it off actually brings it back to a recent activity that affects credit-report scores. Consequently, it’s typically best to focus first on negotiating with creditors that have reported within the last 12 months.

Remember, people make mistakes. Depending on the process, sometimes these settled debts also can be recycled in error by creditors. Collections can be resold an unlimited number of times over the seven years, causing consumers multiple frustrations in dealing with various collection agencies. Having a complete and proper paper trail is essential to establishing proof that the debts are settled.

If there is a charge-off on a client’s credit file, it is important to find out how it got there, when and why. Again, mistakes through human error can be made — mistakes that, once corrected, may increase a person’s credit score. To that end, originators should advise clients to stay on top of their credit scores. Consumers can obtain a free copy of their credit reports annually from the credit-reporting agencies by visiting annualcreditreport.com.                                          


 


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