What’s a Charge Off, and How Does It Affect My Credit?

Priyanka Prakash, JD

Senior Staff Writer at Fundera
Priyanka Prakash is a senior staff writer at Fundera, specializing in small business finance, credit, law, and insurance. She has a law degree from the University of Washington and a bachelor's degree from U.C. Berkeley in communications and political science. Priyanka's work has been featured in Inc., Fast Company, CNBC, and other top publications. Prior to joining Fundera, Priyanka was managing editor at a small business resource site and in-house counsel at a Y Combinator tech startup.
Email: priyanka@fundera.com.

Regardless of the type of business you’re running, you’re going to have to spend money—and lots of it—even if you’re not sure the investment will pay off. Ultimately, there are certain expenses you just can’t avoid. But if your expenses outweigh your income, you might find yourself in debt. And that could you land in danger of seeing a charge off on your credit report.

If you’re falling seriously behind on your credit card or loan payments, there’s chance you’ll see “charge off” the next time you check your credit report. A charge off is when a loan or credit card payment is so late that a lender writes it off as bad debt. You still owe the debt, but now there’s also a negative item on your credit report which could stay there for up to seven years.

Although a charge off will lower your credit score, there are ways to lessen the impact. We’ll walk you through exactly what a charge off is, what it means for your credit, and how to get past it.

How Charge Offs Harm Your Credit Score

A charge off, or write off, is when you’re so late on your credit card or loan payments that your lender thinks they’re never going to receive that payment. Then, the lender removes the anticipated income from their ledger, and document the loss as bad debt. In technical terms, that bad debt is “charged off” or “written off.”

The time period for when a debt is charged off depends on the type of debt and the lender. Under federal law, that time period is six months for overdue credit card payments. Lenders will typically state the time period before a charge off in your signed business loan agreement.

Lenders and credit card bureaus report charge offs to the credit bureaus. On your credit report, a charge off indicates that the underlying account is no longer active—that the credit card is closed, for example—due to the payer being seriously delinquent.

Charge offs can cause serious harm to your credit score since 35% of how your credit score is calculated is based on payment history. The charge off can remain on your credit report for up to seven years, though the impact to your score will lessen over time.

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What Happens After a Charge Off?

An important thing to remember is that a charge off doesn’t forgive your debt. You still owe the underlying debt, and the lender can collect that debt from you at any time.

The lender can either try to collect the debt on their own, hire a collection agency, or sell the debt to a collections agency. If and when they sell the debt, the notation on your credit report is “transferred from” your original lender. The new agency that receives your transferred account becomes will show up as the lender on your credit report, rather than your original lender.

It’s worth noting that seeing “transferred” on your credit report is not always a bad thing. For example, if you’ve closed your account by choice, or if your lender has sold your account to another company while it’s in good standing, those actions might be indicated as “transferred” on your report. So, if you see that word on your credit report, don’t panic right away; it doesn’t automatically mean your lender charged off your account.

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How Charge Offs Affect Your Access to Credit

Nate Causey, a loan specialist at Fundera, says, “If you have an unpaid charge off on your report, then the collection agency negatively reports that a balance is present for every month that the balance remains unpaid.” In other words, for six months of unpaid accounts, you’ll see six negative reports, and each will harm your credit score.

Exactly how much a charge off will lower your credit score will vary with each credit reporting bureau. The higher your score is at the time of the charge off, the bigger hit your score will take, so brace yourself for that. If the charge off is on a business loan, then you’ll also see a negative impact to your business credit score.

The most obvious fallout of a charge off, and the resulting damage to your credit score, is that you’re going to have a harder time securing a small business loan or business credit card down the line. Lenders view your credit score as an indication of your likelihood that you’ll repay the loan on time and in full. If you have a history of paying your debts on time, it’s likely you’ll continue to do so. When you have a long credit history and a high credit score, it indicates to future lenders that you’ll be able to repay their money as you agreed to.

If a charge off lowers your credit score, the lender views you as posing a higher risk. That doesn’t necessarily mean they won’t give you the loan, but they may increase your interest rate. You’ll probably pay more than someone who has a higher score. Along with other information on your loan application (like your business’s age and profitability), a high credit score is one way to ensure that you get the lowest rate possible.

Obviously, having your account charged off or written off can cause you some trouble, and the notation sticks with you for a while. Paying off your debt in full won’t remove a charge off from your credit report, but will change the status to “charge off, paid.” That will reflect more positively on you as a borrower, and make it slightly easier to apply for credit. The further away from the date of delinquency you get, the less weight your charged-off account will carry.

If you have a recent charge off and are planning on applying for a credit card or loan, consider waiting. Not only will that give you some time to get a handle on your current debt, but it will also help your credit score recover a little bit.

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How to Recover From a Charge Off

Ideally, you’re able to keep on top of all your small business expenses, but sometimes debt can get the better of even the savviest small business owner. If you have a charge off on your credit report, there are a few things you can do to lessen the long-term impact:

1. Pay off the debt as soon as possible.

Once you pay off the debt of a closed account, the status in your credit report changes to “charge off, paid.” Again, the charge off will still remain on your report for seven years, but the longer in the past the account was closed, the less of an impact it has on your score. Patience is key here.

Paid collections are still not necessarily a good thing to have on your report, but a paid collection item reflects much more positively on you than an unpaid one. Potential lenders will also be more likely to approve you for other loans or credit cards if your charged off account is paid. If nothing else, it shows that you do ultimately pay your debts, even if it takes you some time.

2. Call the lender or collection agency directly.

Fundera’s Causey recommends directly calling the agency that owns your debt, finding out how much you owe, and paying it right there over the phone. After you do this, he says, “the agency is required to stop reporting the monthly ‘unpaid’ charge off, which by the next credit cycle (or two or three) should correct itself and up your score.”

By dealing directly with the agency yourself, you can be sure you have all the details about your debt, and be sure that your payment is processed. Even if your lender sold your account to a collections agency, you should still call your original lender when you’re amending a charge off.

After you’ve paid down your debt, there’s unfortunately not a whole lot else to do except wait. The charge off will be removed after that seven-year period, and if you pay off the debt, the notation on your credit report won’t carry quite as much weight.

3. Settle your debt.

If you’re financially unable to pay off the full amount of your debt, that doesn’t necessarily mean that you’re stuck. Sometimes, lenders will allow you to settle your debt for less than you owe, particularly if you prove that you can’t pay the full amount with your current income stream. In rare cases, if the amount of the outstanding debt is small, the lender might even forgive the debt. The best way to request debt forgiveness is with a goodwill letter that explains why you couldn’t pay the debt. If there’s a legitimate reason, such as a health emergency, that prevented you from paying, you should explain in the letter.

4. Keep paying down your debt.

There are lots of ways to improve your credit score, but the key is to pay all your debt in full, and on time, every time. Set up automatic payments, if you can, so you never miss a payment on your loan and credit card bills—and risk becoming so delinquent that you’re hit with a charge off.

Even if you can’t pay off the charged off debt in full, make it a priority to continue to pay down as much as possible of your total debt every month.

5. Consolidate your payments.

If you have many credit cards or loans with balances on them, it can get overwhelming to keep track of everything. Consolidating your loans or closing some credit cards means fewer payments to keep track of, and pay on time.

If you are thinking about closing a credit card, though, remember that both the length of your credit history and your credit utilization ratio (how much available credit you’re using, compared to how much total credit you have available) make up your overall credit score.

Closing your oldest card would minimize your credit history’s average age. Closing any of your cards would minimize the total amount of credit you have available—and if you maintain your spending habits, your credit utilization ratio would increase. Both of those factors might temporarily, negatively impact your credit score.

Ultimately, it might be worth it to temporarily lower your credit score so that, in the long run, you can better keep track of your spending and payments.

6. Limit your credit spending.

This is also a good tenet to live by in general: Only use the credit you can truly repay. If you don’t wrack up debt, you can’t be delinquent on it.

Of course, sometimes this doesn’t work. Sometimes you just have to spend money you don’t quite have, and that’s just part of running a business. But if you can limit the amount of times you have to do that, your entire financial situation will be easier to control.

The Bottom Line on Charge Offs

All told, you should try to avoid a charge off on your credit report: It does negatively impact your credit score, can make it more difficult to borrow credit in the future, and is generally just a headache for you.

That said, if you do have one of your accounts written off, don’t panic too much. If nothing else, it can be a useful wake-up call for managing your finances and staying organized. But it is possible to recover from, so you and your business can be back up and running in no time.

If you see a charge off on your credit report, your best course of action is to call the lender or collection agency and pay off that debt ASAP. Even though lenders don’t want their borrowers to have a charge off in their history, paid debt always reflects better on you than chronically unpaid debt does.

In the meantime, be sure to follow best credit practices so you don’t risk further harming your credit score: Only spend what you’re positive you can repay, consolidate your payments wherever possible to lower your debt burden, and always pay your debt in full and on time.

Editorial Note: Fundera exists to help you make better business decisions. That’s why we make sure our editorial integrity isn’t influenced by our own business. The opinions, analyses, reviews, or recommendations in this article are those of our editorial team alone. They haven’t been reviewed, approved, or otherwise endorsed by any of the companies mentioned above. Learn more about our editorial process and how we make money here.

Priyanka Prakash, JD

Senior Staff Writer at Fundera
Priyanka Prakash is a senior staff writer at Fundera, specializing in small business finance, credit, law, and insurance. She has a law degree from the University of Washington and a bachelor's degree from U.C. Berkeley in communications and political science. Priyanka's work has been featured in Inc., Fast Company, CNBC, and other top publications. Prior to joining Fundera, Priyanka was managing editor at a small business resource site and in-house counsel at a Y Combinator tech startup.
Email: priyanka@fundera.com.

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