Charge-Offs 101

Complexity:    

Audience: Loan Servicer or Collector, Upper Management, Loan Servicing/Collections Managers, Administrator, Compliance

Introduction

Sometimes lenders have to charge off an account. There are many different reasons lenders apply a charge-off (also called 'write-off' or 'write-down') and it is an important part of lending. This article will explain what charge-offs are, when they are used, what recovery payments are, and where to find Charge-Off History in LoanPro's loan management system (LMS). If you already understand charge-offs and want to start applying them to loans, read Net Charge-Off Overview.

What is a Charge-Off?

The purpose of a charge-off is to designate a portion of a loan 'uncollectable.' This can include the principal balance, fees, interest, or escrow. A charge off helps lenders do two things: move loans off their books and account for their losses and uncollected revenue.

A charge-off allows the lender to decrease the amount of a loan. If they have a borrower who is not making their payments, the lender may choose to lower the amount of the loan. Lenders choose whether to charge off a loan, which balance to lower, and in what amount.

It is also the lender's choice to charge-off the loan balance or the principal balance. Principal balance is only the principal. Loan balance is the principal balance plus any fees, charges, interest, or escrow associated with the account. The lender can charge off the entire loan balance, which would cover the entire payoff amount, or they can charge off part of the loan balance. The same goes for principal balance: the lender can charge-off the entire principal balance or only a portion.

Charge-offs are logged in LMS as a payment or a credit, either of which would be marked as a charge-off. Payments are more complicated to mark as a charge-off, but it can be done. We recommend our customers log charge-offs as a credit. While a credit is not always a charge-off, it will ask if the agent would like to mark this credit as a charge-off. Using credits reduces the chances of mistaking a charge-off for an actual payment where cash was received.

In LMS, lenders can do charge-offs manually or automatically. The automatic process will be defined by the company's specific charge-off process and then it will run on its own. The manual process is done by agents with the help of wizards. Default Charge-Off Process explains more about what happens inside LoanPro when a loan is charged off.

Recovery Payments

Once a loan is charged off, the balance becomes a 'charge-off balance.' Because the borrower is still legally responsible for that balance, they may still make a payment on the charge-off balance. However, with the loan moved from the lender's books, taking a regular payment might muddle their accounting. Instead, LMS lets agents log recovery payments. From the agent user's perspective, it's almost the same as normal payments, but they'll show up differently in reports.

Charge-Off History

The History tab in the Net Charge-Off section will show you payments or credits that have been designated as charge-offs. Click the date for any of these to view more information about the transaction.

Where do Charge-Offs Fit?

There are many reasons a lender might have to charge off a loan. Charge-offs are usually a last resort. The following are three examples situations where a lender might want to charge off a loan.

Uncollectable Balance

An uncollectable balance is a loan that is no longer being paid. For example, if a borrower hasn't made a payment on their loan in a couple of months and the lender cannot get ahold of them, the lender may decide to charge off the loan. This usually happens when they know the borrower just isn't going to pay them back. In this situation the entire loan balance is usually charged off, but it is up to the lender.

Small Amount

There may be times when there is a very small amount left on a loan. Maybe a borrower paid off the loan but they didn't look at the payoff amount, they only looked at the principal balance and left $0.04 unpaid. In this situation the lender may decide it will cost less money to charge-off the $0.04 than it would to call the borrower and try to get the $0.04 from them.

Forgiveness

If a borrower is not making their payments, the lender will usually try to get a hold of them. If the lender is able to get ahold of the borrower, sometimes they are able to work out a deal. The lender offers to forgive a portion of the loan so the borrower can catch up and start making their payments again. In the long run, it was cheaper to forgive a part of the loan because now the lender can get more of their money back.

Terminology

Term

Definition

Loan balance

The principal balance plus any fees, charges, interest, or escrow associated with the loan. The loan balance equals the payoff balance.

Principal balance

Only the principal balance. The payoff amount will likely be more than the principal balance.

This Feature is Not

A charge-off does not forgive the borrower unless it is specifically a forgiveness charge-off. The borrower still owes the lender that money and it reports on the borrower's credit. But this is a way for lenders to get loans off their portfolio when they are not being paid back.

What's Next?

Net Charge-Off Overview – Explains how to log charge-offs where they are recorded.

Log a Recovery Payment – Provides instructions for logging recovery payments.

Default Policy Charge Off Process – Explains LoanPro's automatic charge-off process. This is a customizable process for our customers.

Charge-Off Accounting – Explains how charge-offs are accounted for.


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