Avoiding The Damaging Credit Impact of Loan Charge-Offs

Many small businesses depend on financing to meet working capital deficits in the early stages, either in the form of unsecured loans or credit cards. However, when unable to pay and delinquent past a certain period, a lender may mark the loan as a charge-off if the business fails to repay debts on time.

A charge-off reflects a bad debt written off in the account books of the lender. In most cases, this happens if the borrower has exceeded the repayment schedule by six months or more. Charge-offs are also known as bad debt expenses, bad loans, irrecoverable debts or non-performing loans, depending on the practice and GAAP applicable in each country. Terminology varies widely.

Avoiding The Damaging Credit Impact of Loan Charge-Offs

Startup loans, marked as a charge-off, can have an extremely negative impact on the credit rating of your business, so it’s always best to avoid them.

Why Do Charge-Offs Occur?

When this situation with unsecured loans occurs, it means the lender has written off your debt in their books. In other words, the lender has lost hopes of recovering the outstanding loan amount. However, the creditor doesn’t write off the loan immediately but would likely wait for at least six months before doing so.

After the lender has written off your debt, it’ll transfer or sell your defaulted loan to a collection agency. This may have a huge impact on your credit rating and can affect your creditworthiness for many years in the future if not eventually repaid.

Moreover, if a lender writes off your debt as charged-off, it doesn’t mean that you won’t need to pay the remaining amount due. Instead, for as long as the loan remains unpaid, you’ll still be subject to legal obligations if the lender or the collection agency deems fit.

What Is The Difference Between A Default And Charge-Off?

While default and charge-off are quite different from each other, the concept isn’t always clear from a borrower’s perspective. The differentiating factors are as follows.

Default: A loan is written as default when the borrower has failed to make payments for a long period of time. Such defaults are not written-off from the lender’s books and will appear on your notes as “Defaults”. Defaulted loans will negatively impact your credit rating, but not as severely as the second type of missed payments.

Charge-off: Unlike default, a label like this unfolds when the lender writes off your loan as a bad debt that cannot be recovered. Moreover, it has a bigger impact on credit ratings until the due sum is paid off. This might show on your credit score for up to seven years from the date of the last missed payment.

Charged-off loans don’t amount to loans that are forgiven. Instead, you’ll still be liable to make the payment of the remaining sum, albeit to another creditor if the debt is sold to a collection agency.

How Does a Charge-Off Impact Credit Scores?

Finding your business in this situation may have an enormous impact on your credit rating as it’s counted as a missed payment for a long period so much so that it had to be marked as bad debt. Considering that even a single late payment may have an impact on your score, a series of missed payments amounting to a charge-off may take away a big share of your business and personal creditworthiness.

This type of event is listed on your credit report both as a late payment as well as being written-off, making the impact twice as severe. As mentioned before, such an entry typically remains on your credit report for seven years from the time of missing the last payment.

Having said that, even after you pay the late amount that’s due, it doesn’t improve your credit rating exponentially. Instead, the status is shifted from “charged off” to “charge-off paid/settled”.

How Can Businesses Remedy A Charge-Off? 

There’s no fool-proof remedy to rectify a charge off or its impact on your credit rating. However, you still have one way to stop it from reflecting on your report. You can get in touch with the original lender of the borrowed amount and attempt to negotiate a new amount or repayment term. Business books suggest that such an approach is followed with a ‘win-win’ ideology in mind. A sensible agreement between parties can avoid bankruptcy and maximise the recovered amount against the loan.

The creditor may consider removing the mark from your credit report, though you’ll need to be ready with a large sum of money to pay off the due debt or at least decrease it demonstrably. So, before you connect with the creditor, you must devise a realistic plan of how much you can pay and how soon. If you’re financially stable enough to pay off the remaining borrowings at once, you’re in a better position to get it removed from your credit history.

How Can Businesses Avoid Charge-Offs?

Avoiding this type of negative mark from a merchant cash advance, outstanding business acquisition loan, or any other kind of startup loan isn’t too difficult unless you’re facing a large financial crisis. You’ll just need to take care of the following:

●        Make the minimum payment on your loan account every month. The more you default every month, the closer you get to a loan charge-off.

●        If you’ve missed making the payment for 3-4 months, have a larger sum of money ready to pay at once. You’ll have the burden of the late payment too.

●      Make realistic plans before applying for unsecured loans. Always apply for a loan amount that’s under your budget to repay.

●        Choose a longer loan repayment term, if available. The longer the term, the smaller the sum you have to pay each month, making the financial burden smaller.


Small businesses do occasionally face cash crunches and depend on financing to weather the storm. That said, lenders generously offer unsecured loan options in multiple formats, whether you need a merchant cash advance, line of credit, or invoice financing to assist.

Still, the absence of collateral brings bigger risks if a business starts facing a deeper financial crisis. A charge-off is one of the last circumstances you want to find yourself confronting if you run a startup as insolvency is one of the biggest killers of small businesses.

To ensure you can avoid this situation, always have the proper financial planning in place before borrowing more or taking on risky financing.