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A charge-off is when you’re so late on your credit card or loan payments that the lender expects you’ll never pay, so they remove the anticipated income from their ledger and document the loss as bad debt. Technically, that bad debt is “charged-off.” That demerit is considered a final status indicator on your credit report that the account is no longer active.
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. (That’s why small business loans were created, after all.) Ultimately, there are certain expenses you just can’t avoid. But when your expenses vastly outweigh your income, you might find yourself in a spot of trouble with a charge-off, which is just one potential outcome of falling into untenable debt. So, what’s a charge-off, exactly?
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. Seems kind of scary, we know—any unexpected ding on your credit report can be alarming, and, truth be told, a charge-off should be.
But don’t worry too much. Although a charge-off will lower your credit score, it’s certainly not the end of the world. We’ll walk you through exactly what a charge-off is, what it means for your credit, and how you can lessen its impact on your credit score.
There are some technicalities involved with a charge-off, which means that there’s some jargon involved. First, let’s clear up some of that jargon so we’re all on the same page about charge-offs—and then, of course, how to amend them.
A charge-off, or write-off, is when you’re so late on your credit card or loan payments—usually six months overdue—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. Technically, that bad debt is “charged-off” or “written-off.”
Regardless of the term a lender uses, that demerit is considered a final status indicator on your credit report that the account is no longer active—that the credit card is closed, for example—and that it closed because it was written off, and not for a less serious reason.
Basically, these two mean the same thing. Neither are great.
When your lender writes off your account, they might choose to sell it to a collections agency. If and when they do this, the notation on your credit report is “transferred from” your original lender. The new agency that receives your transferred account becomes the active entry on your 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.
Now that you have some basics, let’s get down to the real question: What is a charge-off, and how does it impact your credit?
As you now know, a charge-off is not something you want on your credit report.
When your account becomes seriously delinquent, your lender may assume they’ll never get another payment from you, and charge off your account as a loss in their accounting books. Your account will be closed for future use.
Be aware, though, that a charge-off doesn’t exempt you from debt, because you’ll still need to pay your lender that delinquent amount. Often, your original lender will sell the written-off account to a third-party collections agency for a percentage of the account’s value. When this happens, you no longer deal directly with your original lender; all communication (and payments) will go through the agency.
The account will then show up as “transferred” on your credit report. And charge-offs stick around on your credit report for a long time. Seven years, to be exact.
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.
So, for six months of unpaid accounts, you’ll see six negative reports, and each will harm your credit score. How much a charge-off lowers your credit score will vary with each credit reporting bureau (as a reminder, the three major bureaus are Experian, TransUnion, and Equifax), among other factors. But we can say that the higher your score is at the time of the charge-off, the bigger hit your score will take, so brace yourself for that.
The most obvious fallout of a charge-off, and the resulting damage to your credit score, is that you’re going to have trouble securing a small business loan or business credit card down the line. Lenders view your credit score as an indication of your likeliness to repay the loan; 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 you have a lower credit score, though (one dinged by a charge-off, for instance), 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, making you pay more than someone who has a higher score. Obviously you’d rather have a loan with a lower interest rate. 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. Even paying off your debt in full won’t remove a charge-off from your credit report—though it will reflect more positively on you as a borrower, and make it slightly easier to apply for credit. And the further away from the date of delinquency you get, the less weight your charged-off account will carry.
So, if you’re planning on applying for another credit card or a different loan, consider waiting. Not only will that give you some time to get a handle on your current debt, it will also help your credit score recover a little bit.
But seven years is a long time, especially if you’re running a small business and need access to credit. So, if waiting isn’t an option for you, there are some other ways you can try to recover from a charge-off.
In an ideal world, everyone would stay on top of their debt payments at all times and charge-offs would be a non-issue. But, as you know, life (like credit scores) isn’t always ideal!
Charge-offs happen. And if you have a charged-off account on your credit report, there are a few things you can do to lessen its long-term impact.
Once you pay off the debt of a closed account, the status in your credit report changes to “paid collection.” 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 debt 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.
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 off 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.
In the meantime, there are a few additional things you can do to prevent a charge-off from happening again.
This is just generally a good idea, all the time. 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.
In terms of paying down your charge-off debt specifically: Even if you can’t pay off the charge-off debt in full, make it a priority to continue to pay down as much as possible every month.
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 percentages of your overall credit score.
So, 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’s up to you to decide whether it’s worth it to temporarily lower your credit score so that, in the long run, you can better keep track of your spending and payments.
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.
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 credit agency and pay down that debt ASAP. Even though lenders don’t necessarily 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 the 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 lessen your debt burden, and (say it with us!) always pay your debt in full and on time.