DG asks a good question. We hear these terms and wonder what affect they have on
the money that we owe. So let's see if we can't shed some light on the question
and help DG avoid financial hardship.
We'll start with some definitions. For "write-off" we'll turn to the
WallingfordCapital.com site.
"The act of changing the value of an asset to an expense or a loss. A write-off
is used to reduce or eliminate the value an asset and reduce profits."
In everyday English that means the lender has decided that one of it's assets
isn't as valuable as they say it is on the corporate books. For instance, your
promise to pay the bank (car loan, credit card debt, mortgage) is an asset to
them. They have it on the bank accounting records as something that has a
specific dollar value. Generally it's worth what you owe on the debt.
When the bank 'writes-off' part of all of your debt, they're saying that they
don't expect you to pay the entire debt. So they're taking part or all of that
debt and not counting it as an asset of the corporation any longer.
That does two things. First, it reduces the value of the corporation by the
amount of the write-down. Second, it reduces the corporate profits by the same
amount. That reduces income taxes.
OK, so what about a 'charge-off'? For the most part it means the same as
write-off. The main difference is that a charge-off is usually a loan that can't
be collected. A write-off is often real property (building, vehicle, or
equipment) that has lost it's value.
One thing for DG to notice is that these are only accounting transactions. They
do not release him from his responsibility to pay. Fair Isaacs, the company that
started credit scoring, does not say whether a write-off or charge-off has a
negative effect on your credit score. But, they do say that not paying back a
loan on time does. So being late with your payment is a problem whether the loan
is charged-off or not.
Ideally, DG would have contacted the credit card company (or whoever he owed the
money to) as soon as he figured out that he couldn't repay it on time. Often the
lender will agree to a smaller payment over a longer time. If that doesn't solve
the problem, DG could consider a credit counselor.
By the time the debt is charged-off, DG is in pretty deep. His credit score has
been affected. Chances are that all of his credit cards are charging him
'penalty' rates of up to 30%. And, bill collectors are beginning to call him. At
that point, if he can't work out a repayment plan, he may need to consider
bankruptcy.
What about foreclosure? According to Princeton.edu (Princeton University)
it is "the legal proceedings initiated by a creditor to repossess the collateral
for loan that is in default." Typically, foreclosure is used in reference to
real estate property but it can be used for other physical property (your car
for instance).
Foreclosure, unlike our other words, is not an accounting term. It's a legal
term. It means that the company that holds a lien on your property (like a
mortgage) has sued you. The suit will attempt to take possession and ownership
of the property. In other words, you'll lose your house or car.
Once again the credit score is damaged when the payments fell behind. In this
case, the foreclosure will lower it some more.
Whether the lender has started foreclosure or not, the borrower should take the
initiative and contact them if they are having trouble with the payment. The
lender may adjust the payment terms.
DG asks what triggers the bank to foreclose or write-off a loan. There are all
kinds of circumstances, but generally it's when the bank feels that you won't be
able to repay the money you borrowed. Trying to predict exactly when a bank will
foreclose or write-off is difficult and could be dangerous to your finances.
What's the bottom line to all of this? If you can't keep up with your payments,
go to the lender as soon as possible and try to work out an easier payment
schedule. Often they'd rather lengthen a loan than have to write it off or go
through foreclosure.
The other option, simply hoping that things will get better while you fall
behind, is a sure way to hurt your credit score and perhaps end up in legal
troubles.
Gary Foreman is a former financial planner who currently edits
The Dollar
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