How Car Loan Charge-Offs Work

car driving on urban street, low angle view
How Car Loan Charge-Offs WorkBernhard Lang - Getty Images

Auto lenders commonly charge off the debt they're unable to collect. When a borrower stops making payments on their auto loan, the lender deems the debt a liability rather than an asset.

They might send the debt to a collection agency, and collections and repossession efforts might begin. Read on if you're wondering how car loan charge-offs work and what other options you might have if you're unable to make your auto loan payments.

What Is a Car Loan Charge-Off?

A car loan charge-off occurs when a lender moves an auto loan during accounting from the asset category to the liability category. Lenders charge off an auto loan when the borrower stops making payments for a certain period.

This usually occurs after the lender has already attempted to collect the unpaid debt. Moving the debt to liability means they believe they won't be able to collect it.

Why Do Lenders Charge Off Car Debt?

Lenders most commonly charge off car debt for tax purposes. Charged-off debt can include car loans, credit card debt, or any other type of loan.

Lenders initially consider auto loans to be assets because they anticipate the borrower will make their payments and provide income. When a borrower stops paying, the auto loan is no longer an asset but a liability. The lender deems the loan uncollectible and charges off the loan.

The federal government regulates charge-offs. It typically requires lenders to charge off an auto loan within a maximum of 180 days. However, the lender can charge off an auto loan earlier. Federal rules encourage lenders to notify the government of uncollectible debt as soon as they verify nonpayment. This charge-off timeline might be longer for other debt types, such as credit cards.

The amount the lender charges off might not match the debt the buyer owes on the loan. The charge-off amount is the value the lender invests in the vehicle, which might also include security interest, collections efforts, and profits earned if they can sell the vehicle. If the lender doesn't repossess the vehicle, they might list the charge-off as the vehicle's estimated value.

What Happens after a Loan Charge-Off?

A loan charge-off doesn't mean you no longer owe the debt. The lender might send the debt to a collections agency. You can also expect the unpaid debt to go on your credit report. This can make it difficult to qualify for additional loans. If you continue skipping payments, the lender or credit agency might pursue repossession efforts and take the vehicle from you.

Repossession occurs when the original creditor takes possession of the vehicle. Most auto loans are secured loans, meaning they're backed by the vehicle itself. This allows the original lender to take ownership of the vehicle if the borrower doesn't pay.

When a loan is charged off, it shows creditors the original debtor no longer owns the loan. This informs new lenders the borrower didn't pay off the remaining debt, and it has been sent to a collections agency.

The lender or credit agency might also take charged-off accounts to court and file a lawsuit. The creditor or collection agency can garnish the borrower's wages if the court issues a judgment.

What to Expect in the Car Loan Charge-Off Process

A car loan charge-off is primarily an accounting practice. However, you can expect the following to occur:

The Lender Updates Their Accounting

The first step in the car loan charge-off process happens when the lender updates their accounting. This step occurs after the lender has tried to collect payments but hasn't been successful. They deem the debt uncollectible and move it from an asset to a liability in their accounting system.

The Lender Notifies the Borrower of the Charge-Off

After the lender shifts the debt from an asset to a liability in the system, they might send a formal notice to the borrower. However, not all states require this step, so you might not receive a notice if your state laws don't require it.

The Lender Sells the Debt

The lender might sell the debt to a collection agency. This is a third-party company that attempts to collect payment from the borrower. They might contact the borrower via phone, email, or traditional mail. They might even reach out to co-signers on the loan. Some states also allow collection agencies to contact the borrower's employer.

Laws limit how frequently debt collectors can contact you and what confidential information they can share with your employer. Some collection agencies offer attractive incentives to get the borrower to make payments. Depending on the debt collector, they might also agree to a payment plan.

Most collection agencies buy the loans for pennies on the dollar, meaning they might offer the borrower the chance to pay a percentage of their debt to settle it in full. The lender might also pursue a legal judgment, which leads to garnishment of the borrower's wages.

The Lender Notifies the Credit Bureaus

The lender also notifies the credit bureaus that the borrower has failed to fulfill their financial obligations on the loan and they are charging off the loan. This negative credit mark can stay on your credit report for up to seven years. Most lenders will notify all three of the major credit bureaus, which include Equifax, Experian, and TransUnion.

A charged-off debt on a credit report is more significant than a few late payments. You might notice your credit score drops by as much as 100 points. Even if you pay your missed payments and get your car back, a charge-off still typically stays on your credit report.

However, the credit bureaus can change the auto loan status from a charge-off to a settled charge-off. This lets future lenders know you missed payments but are no longer behind.

The Collections Agency Continues Collection Efforts

Lenders can repossess your car in a charge-off. If they then sell the vehicle at auction, they might deduct the sale price from your total debt. If your vehicle is repossessed, a third-party company usually comes to your home or work and takes it.

The company might not notify you before doing so, meaning you could lose any personal property in the vehicle. If the lender repossesses your vehicle, you might have a right to redeem period. If you pay off the debt and any additional incurred costs within a certain period, you can get your car back. Some lenders, however, require you to repay the full loan to redeem ownership.

Can You Drive a Vehicle in Charge-Off?

You might be able to continue driving a vehicle that has been charged off. However, if you default on a secured loan, the lender can repossess. Most state laws require the lender to give you a default notice and time to bring the installment loan current. Depending on your state and the details of the loan, you might avoid repossession by catching up on your late monthly payments.

Some states even allow you to keep your vehicle as long as you agree to a repayment plan. In rare cases, auto loans are unsecured. An auto loan that is unsecured usually means you can continue driving the vehicle, even after a charge-off. This is because an unsecured loan doesn't allow for repossession of a vehicle, even with missed payments.

An unsecured car loan doesn't mean the lender can't repossess the vehicle eventually. It just means they'll have to take you to court first.

Your Options Following a Car Loan Charge-Off

It's important to take action after receiving notice of an auto loan charge-off. You might have a few options available that could help you keep your vehicle or avoid taking a hit on your credit score:

  • Work with the lender: If the lender hasn't yet sent your account to collections, they might be willing to work out a deal to bring your account current. Depending on the lender, they might negotiate your monthly payments, payment date, or how much you must pay to remove the bad debt.

  • Work with the collections agency: If your auto loan has already been sent to a collections agency, you might have to work with that agency. Some collections agencies accept a settlement amount less than your loan balance.

  • File bankruptcy: If you cannot make your other debt payments in addition to the auto loan, you might decide to declare bankruptcy. With a car loan charge-off, you still owe the debt. If you file for bankruptcy, however, the debt might be discharged or restructured based on your total monthly income.

Whatever you choose to do, it's important to acknowledge an auto loan charge-off. Ignoring it can ruin your credit history, making it more difficult to get an auto loan in the future. This could also lead to your vehicle being repossessed. If possible, work with the lender before missing payments. They might have services for debt relief that can help you protect your credit score and keep your vehicle.

If you're not sure how to handle your charge-off, consider working with a law firm. Most law firms give a free evaluation so you can learn about your legal options following charged-off debt. Discussing your case with a bankruptcy lawyer can also be helpful if you're considering bankruptcy. Remember that both bankruptcy and charge-offs affect your credit history.

The confidential attorney-client relationship many law firms offer can help you make the best financial decision for your situation.

Statute of Limitations on Car Loan Charge-Offs

A car loan charge-off can stay on your credit history for up to seven years. However, this doesn't mean the collection agency or lender forgives the loan or will stop contacting you. You might still receive phone calls and letters from them.

Many agencies use prerecorded messages when making their collection calls. Collections agencies frequently use auto dialer programs or other automated technology to try to collect the deficient balance.

Certain laws can protect you and limit what debt collectors can do when trying to collect. For example, you must provide consent before a debt collector can share details about your loan or a confidential relationship with a creditor with anyone other than the original borrower.

Debt collectors should also always verify they're speaking with the original borrower before discussing sensitive or confidential information. It's also important to note that borrowers might be subject to message and data rates in addition to frequent phone calls from creditors.

While debt collectors can continue contacting you, they cannot garnish wages after your state's statute of limitations. This time limit varies depending on the state in which you live. If you're unsure about the laws in your state, check with a local law firm.

Car Loan Charge-Off vs. Repossession: Which Is Worse?

If you stop making auto loan payments, the lender will likely charge off the loan. This may or may not include a repossession, depending on your state laws and the details of the loan. Both a car loan charge-off and a repossession negatively affect your credit score.

With a car loan charge-off, you'll still be responsible for the debt. If you file bankruptcy, it's possible to have the debt discharged. It's best to work with a bankruptcy attorney when considering whether filing for bankruptcy is right for your financial situation. Attorneys evaluate the specific debts you owe and might suggest other options. Do a zip code search in your area to find a bankruptcy lawyer familiar with your state laws.

An auto loan charge off occurs when a borrower stops making payments. You might have options available to bring your auto loan current, which can help save your credit. It's best to learn about your debt relief options before missing payments, as doing so can affect your credit eligibility for future loans.

You Might Also Like