Understanding Write-Offs and Foreclosures

by Gary Foreman


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Could you please give me some idea about charge-off, foreclosure, and write-offs? I need to know on what grounds the banks will go for charge-off or foreclosure? What are the advantages of the above three to the bank? It would be great if you can explain with examples.
DG

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 its 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 or 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 its 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 was 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.

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

Gary Foreman is a former financial planner and purchasing manager who founded The Dollar Stretcher.com website and newsletters in 1996. He's been featured in MSN Money, Yahoo Finance, Fox Business, The Nightly Business Report, US News Money and he's a regular contributor to CreditCards.com. You can follow Gary on Twitter or visit Gary Foreman on Google+. Gary is also available for audio, video or print interviews. For more info see his media page.

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