When a loan is charged off, your lender has written the balance off its books as a loss after roughly 120 to 180 days of missed payments, but you still owe every dollar. The account is closed to new charges, the debt often gets sold to a third party, and the new owner can sue you, report the account to the credit bureaus, and pursue your wages or bank accounts once it has a judgment. In some situations a portion of the balance can also become taxable income.
Here is what actually happens, in the order it tends to hit you.
What a Charge-Off Is, and What It Is Not
A charge-off is an accounting entry. After about four to six months without a payment, your lender reclassifies the loan from a performing asset to a loss for tax and reporting purposes. From the lender’s perspective, the money has moved from “expected to be collected” to “written off.” The account is closed to future charges.
Nothing about that entry cancels your obligation. You still owe the full balance plus interest and fees that accrued before the charge-off. A charge-off is the lender giving up on collecting through normal billing. It is not forgiveness. That distinction becomes important later, especially at tax time.
Where the Debt Goes Next
After the charge-off, the account usually goes one of two directions. Some lenders keep it in-house and hand it to their own recovery department. More commonly, the lender sells the account to a third-party debt buyer for a fraction of the original balance. That buyer now owns the debt and has the legal right to collect the full amount you originally owed.
Once a debt is sold, the original creditor steps out. It will not accept payments on the account anymore. If the debt is sold again, the same rule holds: whoever owns it at any given moment is the party entitled to collect.
Making the Collector Prove the Debt
When a third-party collector first contacts you, federal law gives you a tool worth using. Within five days of that first communication, the collector must send a written validation notice showing the amount owed, the creditor’s name, and a statement of your right to dispute the debt within 30 days.1Office of the Law Revision Counsel. 15 U.S.C. 1692g – Validation of Debts If you dispute in writing within that 30-day window, the collector must stop collection activity until it verifies the debt.
Debts that have been bought and resold sometimes carry errors in the balance, the creditor’s name, or even the identity of the debtor. Disputing forces the collector to back up its numbers before it keeps pushing.
What It Does to Your Credit
A charge-off is among the most damaging entries on a credit file. Credit reporting agencies can include a charged-off account for up to seven years.2Office of the Law Revision Counsel. 15 U.S.C. 1681c – Requirements Relating to Information Contained in Consumer Reports The clock starts 180 days after the first missed payment that led to the charge-off, not the date of the accounting entry itself. When the seven years run, the reporting agencies must remove it.
If the debt is sold, the original creditor typically updates its reported balance to zero to show it no longer owns the account. The buyer may then report the same debt as a collection account, so a single delinquency can produce two negative entries. Both tie back to the same original delinquency date, so they age off together.
Getting Sued on the Debt
The owner of a charged-off debt can sue you. This is what separates charged-off debt from a nuisance you can wait out. The creditor or debt buyer files a civil complaint and you receive a summons with a response deadline, commonly 20 to 30 days.
Ignoring that summons is the biggest mistake people make. If you do not respond, the court enters a default judgment against you for the full amount claimed, plus any interest, fees, and attorney costs allowed by law.3Consumer Financial Protection Bureau. What Should I Do if I’m Sued by a Debt Collector or Creditor? Once a judgment exists, the creditor gets access to enforcement tools that go well beyond phone calls. Even if you think the debt is wrong, you have to show up and raise those defenses. Silence hands the collector a win.
Wage Garnishment
Garnishment is the most common enforcement tool. A court order tells your employer to withhold part of each paycheck and send it to the creditor. Federal law caps the garnishable amount at the lesser of 25% of your disposable earnings for the pay period, or the amount by which your weekly disposable earnings exceed 30 times the federal minimum wage.4Office of the Law Revision Counsel. 15 U.S.C. 1673 – Restriction on Garnishment With the federal minimum wage at $7.25 per hour, that protected floor is $217.50 per week. If your disposable weekly earnings sit at or below that amount, consumer-debt garnishment cannot touch them. Some states set lower caps than the federal one.
Bank Levies
A levy lets the creditor freeze and seize funds sitting in your checking or savings account, sometimes with little warning.5Federal Trade Commission (FTC). What To Do if a Debt Collector Sues You Where garnishment takes a slice of ongoing income, a levy grabs a lump sum at once. Certain funds are protected from levy even after a judgment, including Social Security benefits and Veterans Affairs payments in most situations.
Property Liens
A judgment lien attaches to real estate you own and blocks you from selling or refinancing without clearing the debt first.5Federal Trade Commission (FTC). What To Do if a Debt Collector Sues You The lien does not force an immediate sale. It sits on the title until the judgment is paid or expires, and if you eventually sell, it gets paid from the proceeds before you see anything.
The Deadline for Suing You
Every state sets a statute of limitations on how long a creditor has to file suit. For most consumer debt on a written contract, this window runs anywhere from three to fifteen years depending on the state, with six years being a common midpoint. Once the deadline passes, the debt is time-barred and a court should dismiss any suit filed to collect it.
This deadline is separate from the seven-year credit reporting period. A debt can be time-barred for lawsuit purposes while still showing on your credit report, and the other way around. Under federal debt collection rules, collectors cannot sue or threaten to sue on time-barred debt.
Watch this trap: in many states, a partial payment on an old debt, or a written acknowledgment that you owe it, can restart the statute of limitations from zero. A $50 goodwill payment on a debt two months from becoming time-barred can hand the creditor a new multi-year window to sue. Collectors sometimes press for small payments precisely because of that reset. Before paying anything on old debt, find out where your state’s clock stands and whether a payment would restart it.
When Charged-Off Debt Becomes a Tax Bill
Federal tax law treats forgiven debt as income. The tax code lists “income from discharge of indebtedness” as a category of gross income.6Office of the Law Revision Counsel. 26 U.S.C. 61 – Gross Income Defined The reasoning is simple: you received money when the loan was made, and if you never have to pay it back, that is a financial gain.
When a creditor cancels $600 or more of your debt, it must file IRS Form 1099-C reporting the canceled amount to you and to the government.7Office of the Law Revision Counsel. 26 U.S.C. 6050P – Returns Relating to the Cancellation of Indebtedness by Certain Entities You include that amount as income on your federal return for the year of the cancellation. Forgive $8,000 of credit card debt and your taxable income for that year goes up by $8,000.
A charge-off by itself is not the same event as a cancellation. If the lender sells the debt rather than forgiving it, no cancellation has happened. Confusingly, a charge-off can sometimes qualify as an “identifiable event” that prompts a 1099-C, and creditors and debt buyers can and do keep collecting on a debt after a 1099-C has been filed. If a collector is still chasing you for a balance that generated a 1099-C, a tax professional can help sort out whether you actually owe tax on it.
Exclusions That Can Reduce or Wipe Out the Tax
Two exclusions cover most consumer situations.
- Bankruptcy. Debt discharged in a Title 11 bankruptcy case is fully excluded from gross income, and this exclusion takes priority over the others.8Office of the Law Revision Counsel. 26 U.S.C. 108 – Income From Discharge of Indebtedness
- Insolvency. If your total debts exceeded the fair market value of everything you owned immediately before the cancellation, you were insolvent. You can exclude canceled debt from income up to the amount by which you were insolvent. Owe $50,000 with $35,000 in assets, and you were insolvent by $15,000, so up to $15,000 of canceled debt can be excluded.8Office of the Law Revision Counsel. 26 U.S.C. 108 – Income From Discharge of Indebtedness
To claim either one, file IRS Form 982 with your return for the year of the cancellation. Publication 4681 walks through the insolvency worksheet.9Internal Revenue Service. Publication 4681 – Canceled Debts, Foreclosures, Repossessions, and Abandonments Narrower exclusions exist for qualified farm debt and qualified real property business debt. The exclusion for qualified principal residence indebtedness was available through the end of 2025 and has expired for debts discharged in 2026 unless the arrangement was entered into and documented in writing before January 1, 2026.8Office of the Law Revision Counsel. 26 U.S.C. 108 – Income From Discharge of Indebtedness
Settling the Balance
Creditors and debt buyers often accept less than the full balance to close a charged-off account. Original creditors tend to negotiate less aggressively, sometimes expecting 70% to 80% of the balance. Third-party buyers who paid pennies for the account will sometimes settle for well under half, especially when the debt is close to the statute of limitations.
A few things make these negotiations go better. Lump-sum offers carry more weight than payment plans because they remove the risk of another default. Get every settlement term in writing before you send money, and make sure the agreement says the account will be reported as “settled” or “paid in full for less than the full balance” to the credit bureaus. A phone promise is worth nothing if the collector later claims the payment was partial and keeps pursuing the rest.
Budget for the tax side. Any forgiven portion above $600 may generate a 1099-C.7Office of the Law Revision Counsel. 26 U.S.C. 6050P – Returns Relating to the Cancellation of Indebtedness by Certain Entities Settle a $10,000 debt for $4,000 and the creditor may report the remaining $6,000 as canceled debt income. If you were insolvent at the time of the settlement, the Section 108 exclusion may cover part or all of that amount.