Charge-Off

A charge-off is the accounting step a lender takes when it decides a loan, or part of one, is unlikely to be collected. The lender removes that amount from its loan balance and records it as a loss against its loan loss reserve, also called the allowance for credit losses.

A charge-off is not debt forgiveness. The borrower still owes the money. The lender can keep collecting, sell the debt, pursue a guarantor or take the collateral. Money collected later is a recovery, and it is added back to the reserve.

Lenders track losses with the net charge-off ratio:

Net charge-off ratio = (charge-offs − recoveries) ÷ average loans outstanding

If a lender charged off $400,000 in a year, recovered $100,000 and had $20 million in average loans, its ratio is $300,000 ÷ $20 million = 1.5%.

In the US, bank regulators set timing rules for consumer loans. Under interagency retail credit guidance, closed-end retail loans should generally be charged off at 120 days past due, and open-end loans such as credit cards at 180 days. For business loans, regulators expect a charge-off once a loan is judged uncollectible, which takes judgment about the borrower and the collateral. A partial charge-off writes the loan down to what the lender expects to recover.

Why it matters for lenders

Charge-offs are among the first numbers investors, funders and examiners read. A rising net charge-off ratio can trip covenants in the lender's own borrowing and affect how much capital it can raise. Charging off too late overstates assets. Charging off without a clear policy looks like weak control.

So the process needs clear authority: when a loan is charged off, who approves it, and how recoveries are recorded. Under the current expected credit loss (CECL) accounting standard, charge-off and recovery history also feeds the loss rates used to set future reserves, so the data must be clean.

How it works in practice

A small business loan at a community development financial institution (CDFI) reaches 120 days past due after a failed workout. The lending lead prepares a charge-off memo covering the balance, collection steps taken, collateral value and guarantor status. The loan committee approves a full charge-off of $45,000.

Accounting records the entry, the loan status changes to charged off, and collection continues. Eight months later, the guarantor pays $10,000. The servicer records it as a recovery, not a regular payment, so it flows correctly to the reserve and to the delinquency and loss reports.

In spreadsheets, charged-off loans often vanish from the tracker, and later recoveries get posted as ordinary income. Keeping the loan on one record, with its status and history, keeps loss numbers right.