If you own a small business, odds are you've encountered those times when money seems tight. You need to generate working capital fast just to keep things running. However, there are no forthcoming invoices and adding to your problems, money seems to be going out at a pretty rapid pace. In this type of situation, many small businesses may consider looking into business financing. Whether taking out a short term loan or some other form of commercial loan product, they use this to acquire the cash necessary to keep going.
This is a perfectly reasonable solution to a cash crunch issue. However, problems do arise when the business, after taking out a loan, doesn't generate enough profit to pay that loan back. They fall behind and become delinquent thereby prompting the lender to issue a charge off. A charge off is definitely something entrepreneurs want to avoid at all costs. Keep reading to find out more…
A Charge Off Explained
Simply put, a charge off is issued when a borrower is late in their payments. After repeated late payments, the lender assumes that the loan will stay unpaid and thus the debt will go into the "bad" category. They remove the loan from their books and document it as charged off. So what happens then to you as the borrower unable to pay back the loan…Let's just say your credit is going to take a hit, potentially a major one.
There is usually a six month period of nonpayment after this time is when the debt will revert to the written off or charged off category. This will consequently signal to those who review your credit history that indeed you defaulted on an account and now that account has been labeled inactive in light of a failure to pay.
What is Transferred Debt?
Charged off debt is that which is inactive whereas transferred debt has usually been sold off to a collection agency or some other such company. This too is noted on your credit report. The purchasing company will then deem your account active for collections.
Loan Charge-Offs and the Effect on Credit Score
As noted, your score will take a hit. You will receive reports which show your account delinquency and the consequent point reduction. The amount your score can decrease will vary depending on where your score stood previously and the amount of the debt incurred.
Perhaps though the biggest hurdle you will face when having a charge off on your record is your ability as a small business to secure future funding and/or credit. Whether a business card, small business loan or possibly even a line from a vendor, these may be off limits to you as your record will show that you failed to pay your debts and as a result have a charge off on file.
Lenders do place importance on these things. Remember, in evaluating your company for funding, they're looking at what type of risk you pose. In seeing that in fact you did default on a loan and failed to make payments over the course of six or more months, they will probably be quite hesitant to extend your financing. Also, the charge off lowers your overall credit score which will impact your ability to qualify for a business loan of any type. If you do manage to find funding, the interest rates could be quite high given your past history.
A charge off will remain on your credit report for seven years—this is a long time to have to contend with the issues you will face because of this negative mark on your record. Even if you manage to somehow pay back the debt, the charge off still remains on file and will be seen by those reviewing your application for any future financing or credit.
Can I Avoid a Charge-Off?
Things happen, businesses run low on cash and the money just isn't there to pay debts. Shy of going into default and thus having the loan charged off there are steps you can take that might help you avoid any such action.
Pay Down Your Debts
Start basic…chip away at those debts. Even if you're paying a little each month, you want to get yourself into a healthier financial position; being saddled with debt will not get you there. You might consider automatic payments so that you know the money is being remitted on time.
Communicate
Lenders don't really want to have to charge off a loan, they'd rather get their money back. If you know you're slipping into trouble, reach out to the lender. Explain the situation; they may be willing to renegotiate terms and thus help you when you're down so that way when you do get back up on your feet you will be in a position to pay back your loan.
Consolidate
Perhaps you have multiple loans and/or business cards. Keeping track can sometimes feel overwhelming. Consolidating all of these into one loan might be a good solution for your company. In fact, depending on whom you work with, you could even get a lower interest rate and extended terms thereby helping lower your overall monthly payments. With credit cards, you might think about transferring your balance to a lesser rate card. While this option may not work in every instance, it is definitely worth looking into if you find yourself in a position where you're in danger of defaulting.
Revisit Your Budget
Always go back to the drawing board when you feel a crunch coming on—in this case, your budget. Where can you trim? What might you be able to cut out all together? Maybe there are travel expenses you can expunge, save on utilities somehow, renegotiate with suppliers for cheaper rates. Leave no stone unturned. This is the life of your company after all.
A Charged-Off Account and the Future of Your Business
In an ideal world, you want to avoid a charge off no matter what. Your credit score will take a nose dive, you become a risk to potential lenders, and it simply isn't good for the financial well being of the business. Plus, it stays on your report for seven long years.
However, sometimes it is unavoidable. If you do have a charge off on file, you really need to focus in on improving other aspects of the business's financial record. Be diligent about it and work to get yourself and your company back on track!
If your business is in need of funding, First Union is here. We will try our very best to better your business. Call today!