Credit Card Guide

What is a Charge Off Rate?

15 April 2011 by CreditCardsCo™

A charge off is a debt which a lender has been unable to collect. They can remain on record for up to seven years and can also have a negative effect on an individuals credit score. The charge off rate is the amount of charged off debts divided by the average outstanding balances owed to the issuer from their customers.

In some circumstances a credit card company may decide to charge off unpaid accounts if they feel there is no chance of the debt being repaid to them. It is fairly common for creditors to pass these charge off accounts to debt collection agencies. This can result in two negative marks placed on the debtors record as both the credit card issuer and the debt collector will file a bad credit report on the debt. The credit card issuer reports the unpaid debt as a loss and it is written off.

How Is A Charge Off Rate Tracked And Calculated?

Credit card issuers track their charge off rate because creditors record all of the loans they issue to borrower as assets under "accounts receivable." The creditor monitors their borrowers account to determine if regular repayments are being made. If the borrower does not make payments for several months, usually a standard period of one hundred and eighty days, then the creditor may decide that there is no chance of the debt being repaid. It is then charged off and recorded as a loss.

Credit card charge off rates are calculated by taking the total amount of debts which the credit card issuer has decided to charge off and dividing it by the total average balance still owed by all of the credit card issuers account holders. It is common for credit card charge off rates to increase substantially in times of economic downturn when borrowers are more likely to be unable to pay their debts. There is also a tendency for the fluctuations in credit card charge off rates to mirror the rise and fall of unemployment rates.

What Is The Charge Off Rate Used For?

Credit card issuers, banks, and other lenders report their charge off rates to federal regulators allowing them to keep track of charge off statistics for various different types of lending. Generally, credit cards have one of the highest charge off rates, often as much as three time the charge off rate for an auto loan. Creditors can examine the charge off rate statistics published by the Federal Reserve and use the information to help set interest rates for loans.

Avoiding High Charge Off Rates

Lenders prefer to avoid charge offs on accounts as these are seen as a lost asset. They will often reduce credit limits on, or even close accounts, that they feel are in danger of becoming charge offs. Most charge offs occur when a payment has not been made in one hundred and eighty days. If a debtor makes even one payment before this timeframe has expired, the creditor will reset the count and avoid the charge off until another 180 days has passed without payment. They may also use in house collection professionals to pursue past due accounts as a way to avoid a charge off and increased charge off rates.

In conclusion, a low average charge off rate across the majority of major banks can usually be taken as an indication of a better financial climate, while a low average charge off rate mirroring the unemployment rates will indicate economic struggle. Every charge off a lender makes is recorded as a loss. Therefore lenders will attempt to avoid charge offs where possible.

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