Was paying off a defaulted card balance a good idea?

This post originally appeared January 25, 2018 on CreditCards.com as “‘Q&A: What to do after defaulting on a credit card

By Barry Paperno

Dear Speaking of Credit,
I recently got defaulted from a Banana Republic credit card for missed payments. That has affected my credit score, and I am now trying to get back on track.

I recently paid off the remaining balance in full and am looking to cancel this card for good.

My question: Was paying off the remaining balance in full the best decision credit-wise? And what do you recommend for me moving forward? – Daniel

Dear Daniel,
Let’s start with the no-brainer answer to your first question of whether paying off the remaining balance was a good idea. Absolutely!

Despite those missed payments that hurt your credit score, you did right by paying off that card balance, since doing so can:

  • Stop additional interest and late charges.
  • Prevent a collection agency from entering the picture.
  • Start the “credit rebuilding clock” ticking.

However, now that the balance has been paid, whatever you do, don’t close the card. You’ll see why below.

Your second question, looking for a recommendation on how best to move ahead, cannot be addressed quite so simply – thanks in part to your choice of terminology.

What a ‘defaulted card’ means
Usually by the time you default on a card, the card company has:

  • Canceled and closed the account.
  • Written the debt off as a loss.
  • Reported the account to the credit bureaus as a “charge-off.”

Since you imply that the account remains open, my guess is you probably paid it just in time to avoid setting the above wheels in motion. If so, consider yourself fortunate. You now have the opportunity to turn this critical situation around.

On the other hand, the account may very well have defaulted and you may just not yet be aware that it has been closed in addition to being charged off.

Such misunderstandings of where a problem account truly stands are not unusual given the often confusing nature of customer communications and credit reporting policies. We’ll hope this is not the case.

Now, let’s look at both of these possibilities and how best to proceed onward from each.

When a defaulted card is paid in the nick of time
This is obviously your best-case scenario. Instead of closing the account as you’re considering, keep it open and active by making small charges and paying the balance in full each month.

This renewed activity will allow you to begin countering some of that past negative credit history with a record of consistent on-time payments and low credit utilization – the amount you have borrowed compared to your credit limits. The lower the credit utilization, the bebtter.

Then, heading into the future, do whatever it takes to avoid a late payment on any credit account.

Whether that means keeping your balance(s) at a manageable level, setting up automatic payments, only charging one or two tiny amounts – cup of coffee or your Netflix bill, for example – or all of the above, make a perfect payment history over multiple accounts your top priority.

When the defaulted account was closed and charged off before you paid it.
Once the card has been closed and charged off you’ve forever lost the option of reopening it to re-establish that good pay history and low utilization.

  • Instead, look to any other existing open card accounts that remain in good standing or consider opening a secured credit card that reports monthly to the credit bureaus. A secured card operates much like a regular credit card, except the cardholder makes a security deposit to open the account. Often equal to the credit line, that money assures the card issuer that a borrower won’t rack up a bill and walk away.
  • You can alternatively go with both options, as the more “good” cards you have, the more points to your score these score-rebuilding efforts are likely to deliver.
  • Along with missing any more payments, what you also don’t want to do over the coming months is apply for any unsecured cards, as your low score will likely lead to denial.

Fortunately, all credit scoring models treat secured cards just like unsecured cards when evaluating their payment history, amounts owed, length of credit history and other sets of scoring calculations.

Many secured cards convert to an unsecured card after one year of responsible use.

How long will rebuilding credit take after a default?
Whatever credit rebuilding challenges lie ahead, you’ve crossed the first, and most important, hurdle – you paid off the debt. For that you deserve a big pat on the back.

Now you can move forward by re-establishing a positive credit picture over the long haul, which is more likely to take two to three years than a few months.

This length-of-time question will depend on many unknowns, including the extent of this and any other similar credit setbacks, and the type(s) of credit you might be seeking in the future.

Credit cards, car loans and mortgages tend to require different scores, income levels and other requirements.

Over the next couple of years, you can get the best handle on your rebuilding progress by monitoring your credit score using one of the many free credit monitoring services, such as those offered by CreditCards.com.

Then, watch as your score regains the respectability it once had.

Good luck!

4 thoughts on “Was paying off a defaulted card balance a good idea?

  1. CaliSteve

    My friend paid off a charged off account and his score increased by 28 points.
    Also, if the creditor still owns a charged off debt, they will most likely continue to report the account on a monthly basis. That will supress your score.

    Reply
  2. Barry Paperno Post author

    Always good hearing from you, CaliSteve! And you’re right about some card companies continuing to report unpaid charged-off debt, which can keep your score from recovering as quickly as it would if, as some card issuers do, stop reporting as of the charge-off date.

    For some scoring factors, such as those that measure the length of time since the charge-off, there’s no impact from the continued updating of the “reporting date.” That is, as long as the date of last activity (Equifax), closed date (TransUnion), or status date (experian) continues to correspond to the date of the charge-off. These are the dates used for many score calculations, regardless of the reporting date.

    However there are at least a couple of ways this tactic can hurt consumers with unpaid charged-off debt:

    ** If any of the above dates for each bureau are missing from the trade line, the score uses the reporting date instead — a date that will perpetually remain at “one month old.” As a result, no matter how long ago the charge-off truly occurred, it will always be considered “recent.” If you see this, dispute it with the credit bureau by providing the actual charge-off date.

    ** By rolling that reporting date each month, the unpaid balance and past-due amounts continue to hurt the score — the higher the dollar amounts, the lower the score. Whereas when they stop reporting, those effects diminish over time as the charge-off ages.

    Thanks for raising this important point, Cali!

    -Barry

    Reply
  3. Barry Paperno Post author

    The reporting date will always be just that, the date it was last reported aka “updated.” It can be triggered by a payment or an adjustment of some kind or, as I suspect, the creditor attempting to keep the score down, either as punishment or to make it more likely to get paid to raise the score.

    Date of first delinquency (DoFD) doesn’t enter the picture here, or anywhere in scoring really. It’s more of a credit reporting date, i.e. determines how long a derogatory item remains on the credit report.

    I might be wrong on this historically, but if my memory serves me well it seems unpaid charge-offs used to stop reporting once the charge-off status was first reported. Then they would only report again when a payment or other activity occurred. Now more and more I’m hearing of card companies doing just what you’re saying, continuing to report when there’s been no activity.

    To understand what this means for a credit report and score with an unpaid charge-off that continues to report, keep in mind that:

    ** The date of last activity/closed/status dates have the most impact on the score, since they measure the time since the last delinquency.

    ** The reporting date is more likely to affect $$ calculations , e.g. balance, utilization, past due amounts — important, but not quite as much as the “time-since” calculations.

    And as noted earlier, the absence of the date of last activity/closed/status dates causes the score to default to the reporting date, which, if more recent, will be worse for the score than if it had stopped reporting as of the charge-off. This is often what’s happening when you get a score factor saying an old delinquency is “too recent.”

    Make sense?

    -Barry

    Reply

Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out /  Change )

Google+ photo

You are commenting using your Google+ account. Log Out /  Change )

Twitter picture

You are commenting using your Twitter account. Log Out /  Change )

Facebook photo

You are commenting using your Facebook account. Log Out /  Change )

Connecting to %s