Thursday, June 7, 2012

What are the effects of credit card debt on your credit history?

I recently had to answer this question and here is my answer.

That is really a very broad question, so I will focus only on the effects that bad credit card debt has on your credit file and some of the potential consequences. By bad debt I mean the outstanding account balance on which even the minimum payments have not been made.

There are stages in the delinquency of credit card debt. If even the minimum payment has not been made for up to 90 days, the account will be still at the card issuing bank. It will be reported in your credit file simply as a late payment and it will be specified how late (30, 60 or 90 days). Your credit worthiness is slightly damaged and your credit score will drop a little bit.

If no payments have been made for more than 90 days, the account will be "charged-off". This refers to a debt, declared to be uncollectible and removed from the bank's balance sheet. Once charged-off, the account is sent to a collection agency and reported to the credit bureaus as a charged-off account. This is a lot more damaging than being late on a payment and your score will drop substantially.

The collection agency usually has the account for no longer than 60-90 days and their settlement parameters are very rigid. Typically they will not accept a settlement for an amount smaller than 80%-90% of the outstanding balance (including interest and other financial charges).

After 60-90 days, the bank will recall the account from the collection agency, place it in a pool of charged-off accounts, that have already gone through the same cycle, and sell it to a debt buyer. A typical bank sells such accounts quarterly.

Once a debt buyer gets the account, they become the new creditor and can report the account again to the credit bureaus. So 1 account can generate several derogatory notes in your credit file, each one further damaging your score.

If it remains unpaid, the debt buyer can and will sell the account to another debt buyer and the story will repeat itself.

The earlier in this cycle the account is paid, the better for the credit history. It will be updated as a "paid collection" account, which is a great deal better than showing as a collection account. Yet, it will take time for the credit score to get back to where it was before the delinquency.

How has credit card debt affected your own credit score? How did you deal with it?

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Roy said...

That is one of the most detailed descriptions I've seen.

Maria said...

So how many times can the account be sold?