Bad debt is debt that has gone unpaid for so long, there is little chance of it ever being collected. The creditor writes it off as a financial loss due to default, which is called a charge-off. The account is then closed, and the debt may be sold to a debt buyer or transferred to a collection agency. Creditors who are determined to collect their money sometimes take legal action.
When a credit card, loan or medical bill hangs in limbo for too long, it can also hurt your credit score. A charge-off on your credit report is a huge red flag. It shows anyone who checks your report that you have written off the debt and don’t intend to pay it back.
A delinquent account can come back to haunt you for years, especially if you want to get a loan or take out a new credit card. If you do get approved, you will pay a much higher interest rate because you are considered at high risk of defaulting. Even if you eventually do pay off the overdue debt, the charge-off will remain on your credit report for 7 years.
If you have a history of not paying bills on time or owing too much money, creditors consider you a bad credit risk because there is a good chance you will default on future payments. On a scale of 300 to 850, your credit score probably falls below 580, which means you will have a harder time achieving financial milestones, such as being approved for an auto loan or mortgage. If you do somehow receive credit approval, the odds are that you will receive less favorable terms, such as high interest rates or annual fees. The most common causes of bad credit include late payment of bills, bankruptcy filing, charge-offs, and defaulting on loans.
When you make late payments or default on the payments altogether, the lender or creditor reports it to the credit bureaus. The information is included in the your credit report, which lenders and other creditors use to make decisions on whether or not you are a good candidate to pay back a loan.
Having a good credit score is important because it helps you borrow money at lower or 0% interest rates. For example, if you have excellent credit, you might qualify for a 0% APR credit card, which offers no-interest financing for an extended period of time. Using this type of card can save you money in interest and help you pay off your debt faster. In addition, you can avoid security deposits and pay lower down payments on some loans. This can free up some of your cash to put toward other financial goals and expenses.
When you add up all the savings in interest, a good credit score can save you thousands of dollars. If you are challenged with a bad credit score, you can take steps to improve it.