Charge-offs

Understanding Charge-Offs

When a credit provider determines that a debt is unlikely to be collected, they charge off the account. They typically cease collections activities, report the defaulted account to the credit bureaus, and mark it in their records for operational, tax, and reporting purposes.

What does a charge-off mean for the borrower?

{emphasize}

When a debt is marked as charged-off, credit providers typically take similar actions as they close the account and remove it from their books. When done manually, these actions cost the lender additional time and resources, deepening the loss from each account. But with an automated charge-off process, an LMS can manage these actions without requiring any more attention from the lender.

• Internal bookkeeping. The creditor will mark the account as “charged off” in their LMS. This typically brings some other administrative changes with it. They’ll cease normal collections efforts, exclude the account from reports on their portfolio, and make note of the losses for tax purposes.
• Credit reporting. The provider will often report the default to one or more credit bureaus.
• Borrower communication. Some credit providers might simply cut ties, but others make a final attempt to reengage the borrower, warning them about the penalty to their credit score and perhaps offering them enrollment in a hardship program or refinancing product.
• Debt reselling. The provider might also resell the debt to another lender, either permanently liquidating it from their books or in hopes that the purchaser can rehabilitate the account.

{emphasize}

For the borrower, this brings a number of long-term consequences, primarily resulting from the hit to their credit scores. A charged-off account could significantly hurt their score, making it harder to get new credit products in the future. Even when credit is available, it might come with a higher interest rate or fewer rewards. And because the charge-off can remain on their credit report for up to seven years, borrowers will be feeling its impact well into the future.

Healthy charge-offs

While charge-offs generally refer to accounts that fall heavily delinquent and are at risk of defaulting, credit providers may also charge-off debts when successful payments reduce the remaining balance down to a sum small enough to be simply forgiven. Continued collections efforts may be more costly than the account’s remaining balance, and forgiving a small debt can help win long-term customer loyalty.

Similar to other charge-offs, the credit provider will mark the remaining debt as uncollected and begin the account closure process. But unlike a delinquent charge-off, the provider will report the debt as fully paid to the bureaus, and will most likely offer other credit products to the borrower.

Managing charge-offs

Non-performing accounts bog down a credit operation’s efficiency, pulling away a disproportionate amount of resources in collections efforts that are unlikely to result in any future payments. Credit providers, then, have a strong incentive to determine when an account is uncollectable as early as possible, then cut their losses through a charge-off.

Streamlining the charge-off process

When a charge-off is necessary, creditors should close the account with as little cost and effort as possible. First, they should automate their process. Many modern credit platforms will allow creditors to implement custom automations aligned to their policies and business logic. 

When an account is so many days, dollars, or payments past due, an LMS can start an automatic charge-off process, either flagging the account for review or handling all the administrative tasks through a fully automated workflow.

If manual reviews are necessary, task management tools like a ticketing system or escalation ladder can help agents review and charge-off accounts as efficiently as possible.

Give borrowers tools to address charge-offs

Credit providers should also remember that the hit to their credit score gives borrowers a strong incentive to avoid and address charge-offs. It’s not unlikely that a borrower is already looking for effective ways of removing charged-off accounts from their credit report. If their credit provider gives them a clear path towards addressing it, they may be able to re-engage the borrower and recoup credit losses.

{emphasize}

As an account approaches and undergoes a charge-off, credit providers should communicate with each borrower the options they have for resolving charged-off accounts:

• Resumed payments. When evaluating the decision to pay off charged-off accounts, many borrowers get the mistaken impression that it’s already too late. Creditors can offer to remove the charge-off when regular payments resume, perhaps with an added incentive of forgiving some interest or late fees that accrued during the delinquency.
• Negotiation and refinancing options. Some borrowers may be interested in repaying their debt, but financial difficulties have made it difficult or impossible to keep up with the original payment schedule’s interest and late fees. In these cases, credit providers can offer hardship or refinancing options, giving the borrower a path towards sustainable repayment, potentially leading to a "paid charge-off" on their credit report. 
•  "Pay for delete" agreements. If a borrower resurfaces months or even years after their account was charged off, it may be easier for both parties to just agree to a one-time payment for the total remaining balance, sometimes called a "pay for delete" agreement.

{emphasize}

Upgrade your charge-off process

Delinquencies, defaults, and charge-offs are an inherent risk of offering credit—it’s not a question of whether you’ll see these problems, but when. A strong portfolio management strategy needs to take steps both to prevent charge-offs where possible as well as mitigate their operational burden when they do arise.

LoanPro’s modern credit platform offers tangible solutions for managing charge-offs, significantly lowering delinquency and default rates within just months of migrating. If you’re looking to streamline charge-offs, reach out to us. We’d love to talk over your current process and show you how LoanPro can optimize it.