Author Topic: Charged-off versus full default  (Read 7085 times)

Galli

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Charged-off versus full default
« on: May 02, 2015, 11:03:11 AM »
Hey Guys,

Thinking about this for a month or so and wondering if anyone has an answer.  Let's say you take out a large propser loan of 25,000.  You pay for 3-months and then proceed to let the note be charged off.

What does this do to your credit score if you end up paying off the principal balance of the note?  Not fully in default, repaid principal balance in full - benefit of doing so is zero interest on the principal balance which is considered "charged-off" and your credit score doesn't implode from a full blown bankruptcy.

Feels scamm-ish to me but I've had a note do exactly what i'm describing.  Went late, charged off, now seeing regular payments on the principal balance which is no longer accruing interest...  Seems pretty unfair to me but I guess I should be happy this person is repaying their principal, even if I have an opportunity cost on the principal balance i'm owed.



kya

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Re: Charged-off versus full default
« Reply #1 on: May 02, 2015, 12:15:28 PM »
the credit score in this case would still be badly damaged

rawraw

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Charged-off versus full default
« Reply #2 on: May 03, 2015, 03:19:28 PM »
Just because he isn't paying interest doesn't mean it's not going to happen. When a loan goes bad it goes on non accrual. Payments are applied fully to principal unless the credit is well secured and at no risk of loss. He still owes the interest. Normally the borrower never knows the accounting for their payment, just what they owe. Being charge off doesn't impact them unless it's sold and the phone calls come from a different source

Galli

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Re: Charged-off versus full default
« Reply #3 on: May 03, 2015, 06:16:05 PM »
Just because he isn't paying interest doesn't mean it's not going to happen. When a loan goes bad it goes on non accrual. Payments are applied fully to principal unless the credit is well secured and at no risk of loss. He still owes the interest. Normally the borrower never knows the accounting for their payment, just what they owe. Being charge off doesn't impact them unless it's sold and the phone calls come from a different source
They pay interest after the loan balance is repaid?

the credit score in this case would still be badly damaged
Is the credit score better off if repaid eventually?

rawraw

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Re: Charged-off versus full default
« Reply #4 on: May 03, 2015, 06:17:59 PM »
Just because he isn't paying interest doesn't mean it's not going to happen. When a loan goes bad it goes on non accrual. Payments are applied fully to principal unless the credit is well secured and at no risk of loss. He still owes the interest. Normally the borrower never knows the accounting for their payment, just what they owe. Being charge off doesn't impact them unless it's sold and the phone calls come from a different source
They pay interest after the loan balance is repaid?

the credit score in this case would still be badly damaged
Is the credit score better off if repaid eventually?
You're getting confused the contractual amount owed and interest. They'll have to pay whatever interest would have accrued. Later payments, if exceeding principal, would be all interest. But to the borrower it's just another $50 payment closer to paying the obligation off. The balance the bank sees vs the borrower isn't always the same

kya

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Re: Charged-off versus full default
« Reply #5 on: May 03, 2015, 07:47:17 PM »
Just because he isn't paying interest doesn't mean it's not going to happen. When a loan goes bad it goes on non accrual. Payments are applied fully to principal unless the credit is well secured and at no risk of loss. He still owes the interest. Normally the borrower never knows the accounting for their payment, just what they owe. Being charge off doesn't impact them unless it's sold and the phone calls come from a different source
They pay interest after the loan balance is repaid?

the credit score in this case would still be badly damaged
Is the credit score better off if repaid eventually?

yes but its still lower because of default

AnilG

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Re: Charged-off versus full default
« Reply #6 on: May 03, 2015, 11:06:24 PM »
OP might be confusing the difference between borrower's contractual responsibility and how lender is recognizing the payments received. OP might be trying to link them together where there is no link.

Once borrower has defaulted, lender is permitted to treat any future monthly payments toward principal only until principal is paid off. If lender recognizes the future monthly payments as part principal and part interest then lender would have to pay taxes on the interest portion, not a favorable treatment.

Any recognition and reclassification of revenue by lender has nothing to do with borrower's responsibility.
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Fred

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Re: Charged-off versus full default
« Reply #7 on: May 04, 2015, 06:10:26 AM »
My understanding is that once a loan is charged-off, it remains on the borrower's credit report for 7 years.

Repaying the outstanding principal may benefit both the borrowers (paying no interest on the charged-off principal) and lenders (getting something back after treating it as a loss). 

However, borrowers need to really weigh this against having a 7-year blemish on his credit report.

IMO, this is not a worthy endeavor for any borrower. 

If borrowers have the money to pay off the principal, he/she should pay it off without resorting to the charge-off route.

Galli

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Re: Charged-off versus full default
« Reply #8 on: May 04, 2015, 09:08:43 AM »
thanks for the replies.

So in summary:

Charged-off loan eventually paid off results in slightly less worse credit impact although still really bad - Makes sense
Charged-off loans accrue interest but isn't shown  - begins paying off after principal balance is paid.
Borrower sees full obligation (principal + interest), will end  up paying (more than ?) the original obligation as if it was amortized originally?


rawraw

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Re: Charged-off versus full default
« Reply #9 on: May 19, 2015, 07:13:09 AM »
thanks for the replies.

So in summary:

Charged-off loans accrue interest but isn't shown  - begins paying off after principal balance is paid.
Borrower sees full obligation (principal + interest), will end  up paying (more than ?) the original obligation as if it was amortized originally?
No, the loan stops accruing under my example (and it's how most of the banks in the USA do it).  But once you pay off the principal, you still have remaining contractual payments under the original terms.  When those payments are received, they go to income.  Or the borrow demonstrates a renewed ability to pay, under which you place the loan back on accrual.  Accrual recognizes income regardless of whether its been recieved yet or not.

The borrowers obligation will only change due to late fees, etc.  But changing how the money is applied doesn't increase the amount they owe.

All this stuff is fairly heavily regulated and the punishment for screwing up can be brutal

Galli

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Re: Charged-off versus full default
« Reply #10 on: June 07, 2015, 09:28:16 AM »
Thanks for the replies rawraw, appreciate it.  I lack (personal and professional) experience in how this is handled in the real world. Mind if I ask an additional question

"But once you pay off the principal, you still have remaining contractual payments under the original terms."

How do they determine the remaining contractual payments if the principal balance is paid in full?  Do they simulate how much interest would have accrued over the remaining unpaid months of the loan?  I don't understand how there can be 'contractual' obligations left if interest hasn't accrued since default and principal has been proceeded to be paid in full.