If your list of resolutions includes better money management or, better yet, an all-out war on debt, then hearing from a collection agency is the definition of a bad start to a new year.
Also, a bad middle or ending.
As stressful as it is, keep in mind that your options when a collection agency contacts you are greater than the amount of anxiety you’re likely feeling.
You’re also not alone. The Consumer Financial Protection Bureau reported that as of 2022 nearly one quarter of all consumer credit reports had a collections tradeline. A tradeline is an item on a consumer’s credit report that contains information about an individual’s alleged unpaid debt.
As common as it might be, there are serious consequences to ignoring a collections agency contact. That doesn’t mean your best option is to immediately put a check in the mail. You definitely shouldn’t do that either.
In fact, you should avoid paying a collection agency without first investigating all your options. Paying a collection agency can be a bad move that does serious harm to an already precarious financial situation.
It’s important to know the preliminary steps you should take and the subsequent strategies you might employ before dealing with debt collectors.
What Is the Difference Between an Original Creditor and a Debt Collector?
Let’s say you’ve defaulted on credit card payments. The bank or other lender holding your account is the original creditor. Most likely it’s Chase, American Express, Citi, Capital One, Bank of America, Discover, US Bank or Wells Fargo since those did the most business in 2023. They’re the folks who lent you the money in the first place.
Original creditors such as the ones listed above – or hospitals if it’s medical debt – may use their own in-house debt collectors to contact you about overdue debts.
Or they may turn over your account to a third-party debt collection agency, a company whose reason for existing is to regularly collect debts owed to other businesses.
If you agree to pay a debt collector, they aren’t the original creditors, but they are the one making money off your payments.
How Debt Goes From the Original Creditor to a Debt Collector
If an original creditor believes your delinquent account is a lost cause, they may opt to turn over that account to a debt collection agency.
The original creditor is cutting its losses, selling your account for less than what you owe, often substantially less than what you owe.
You should expect to hear from your bank or creditor’s debt collection department within 30-60 days of failing to make a minimum payment on your account. There’s no set rule about how long an original creditor will attempt to collect on a delinquent account before turning the account over to a collection agency.
Whether you’re dealing with an original creditor or (especially) if you’re dealing with a collection agency, debt settlement is an option that might best fit your circ*mstances since many debts can be settled for less than what you owe.
“Let’s say you have medical debt, as many people do because their policies have high deductibles,” John Wood, founding attorney of Grant Park Legal Advisors in Chicago, said. “You may be able to call the hospital directly and negotiate the amount you owe.
“For instance, you say, ‘Look, I don’t have $10,000 I owe and won’t anytime soon. But friends and family are helping me, and I have $6,000.’
“That hospital may be willing to work with you and recall a debt they sent to collections.”
How Do You Find Out if Your Debt Has Been Sent to Collections?
In many cases, if you’re only a month or two behind on your payments the original creditor still has your account. Banks and other lenders typically turn over delinquent accounts to collection agencies after 4-6 months without payment.
The original creditor should inform you that your account is being sent to collections. If that happens, consider it a wakeup call.
Dealing with an original creditor may offer the best opportunity to get on a friendlier payment plan or to settle the debt. Just know that settling a debt means paying a lump sum.
“Paying a debt in a lump sum is a great idea, but sadly, it does not automatically remove the debt from your credit report,” Young Pham, financial planner with Biz Report, said. “The only thing that happens immediately is the fact that the debt’s status will be updated to show that it has been paid.”
One way to find out if your debt has been sent to collections beyond calling the original creditor for a status update is to routinely check your credit report. It’s good advice whether you have a delinquent account or not.
What To Know Once Your Debt Goes to a Collector
There are strategies that can help you get out of paying collection agencies, if you know the rules involved.
It’s important to understand the agency’s rights to collect a debt and the legal recourse at its disposal but also to understand the rules they must follow.
The Debt Collector Must Give You Proper Notice
Legitimate collection agencies – yes, there are scammers out there so be wary – are required to contact you before reporting your debt to a credit bureau. They must contact you in person, over the phone or via mail or email.
Debt collectors, as part of the Fair Debt Collection Practices Act, must send you a debt validation letter if you request one. You then have 30 days to dispute the debt.
Ignoring Their Call Can Lead to More Trouble
We can’t stress enough that ignoring contacts from a debt collector is never a good idea and could result in the debt collector filing a lawsuit and eventually garnishing wages. Collection agencies have already paid the original creditor for your account and aren’t likely to stop contacting you.
What’s more, talking with a debt collector is a critical first step toward ensuring the debt is legitimately yours. That contact can potentially present an avenue for you to settle the debt and mitigate credit score damage.
Increased Interest Penalties
Ignoring a collection agency can result in continued interest penalties. While collection agencies can’t impose their own interest penalties for non-payment, they can enforce the terms of your original loan and in some cases tack on additional fees.
Effects on Your Credit
A debt that goes to collections can damage your credit report and remain on your report for seven years.
That can be the case even if you pay off your debt. Also know that while there can be some benefit to rebuilding your credit score by paying off your debt through a collection agency, don’t expect to see an immediate rebound in your credit score.
Is It Better To Pay the Company or Collections?
It’s typically better to pay the original creditor instead of paying a collection agency. Ideally, you’d reach out to the original creditor before your account is sent to collections.
“Telling your lender you’re having financial difficulty allows them to be sensitive to your situation,” Wood said. “They’re going to find out when you start missing payments anyway.
“Look, bad things happen to good people. If you don’t reach out to your lender and try to work out an arrangement, you might look like you’re trying to scam them when you start missing payments.”
Dealing with an original creditor likely offers more options for repayment, including debt settlement, and will prevent a more damaging hit to your credit score.
Falling behind in payments on a credit card is a fender bender compared to the damage done when “collections” shows up on your credit report.
Never Pay a Collection Agency Without Weighing All Your Options
You may eventually decide you must pay a collection agency to prevent a lawsuit. But don’t panic and send off a payment without checking all your options and taking stock of what you can afford in a repayment plan. Do you have the wherewithal to handle this? Is bankruptcy a better option?
Get proof that the money owed is a legitimate delinquent account once held (or still held) by a creditor you recognize. Call that creditor. Verify the amount and the interest and late fees attached to the debt.
Keep in mind there’s a statute of limitations on different kinds of debt that varies from state to state. If that statute of limitations has expired, you can’t be sued for the outstanding debt. Go online or call an attorney to check on your state’s statute of limitation laws.
“It may be that the debt in collections is already past the statute of limitations,” Wood said. “An agency might try to get you to make a small payment, as small as $10, with the promise of writing off half your balance. But that just restarts the statute of limitations clock all over again.”
While you’re investigating your options, Wood cautions against ignoring collection agency contacts and strongly warns against ignoring a court hearing notice.
“You should always appear in court,” Wood said. “Even if you believe the debt is beyond the statute of limitations. If not, you risk a default judgment against you.”
That could lead to wage garnishment, bank account freezes and property liens.
Some people, especially if they’re trying to wipe their slate clean and commit to responsible money management, might elect to pay a collection agency to simply resolve the issue and stop the collection calls, emails, etc.
Just keep in mind that paying a debt in collections will have a significant impact on your credit score and can remain on your report even after the debt is settled.
What Happens to Your Credit Report if You Pay a Collection Agency Directly?
It might seem counterintuitive but depending on the credit model used, paying a collection agency directly may not positively impact your credit score.
Even if it does ever so slightly, it could take years to rebuild a credit score whether you pay a debt through collections or not.
Paid or unpaid, a debt that goes to collections will stay on your report for seven years, though in some states (New York for instance) a collection debt could fall off in five years.
“When a defaulted loan is taken by a collection agency, it is typically reported as a “collection account” on the users’ credit report,” Young Pham said. “This will obviously lead to a huge drop in your credit score. This is because collection accounts are considered highly negative by credit scoring models.”
Can You Negotiate if Your Debt Is in Collections?
If your account is months overdue, you’ve ignored contact from your original creditor and your account is sold to a collection agency, you might still have some leverage.
The collection agency is looking to make money on the account they bought off the original creditor (often for approximately 5% of what is owed) and might be open to negotiate a settlement.
The Consumer Financial Protection Bureau advises debtors to try to negotiate with the debt collector, explaining that you might have more room to reduce the amount you owe than you did with the original creditor since the debt collector typically purchases your account for pennies on the dollar.
The CFPB advises that individuals who’ve exhausted their options present the debt collector with a repayment plan based on their financial situation and get any agreement to a repayment plan or settlement plan in writing. The bureau also advises working through a nonprofit credit counselor or attorney in certain circ*mstances.
Creating a Debt Management or Debt Settlement Plan
It’s more than likely – much more than likely – that if a collection agency contacts you for a significant debt owed, you won’t have the financial resources to pay it off in a lump sum.
Under those options, a debt management plan or a debt settlement plan could be your best option.
A debt management plan (DMP) is a strategy to eliminate unsecured debt such as credit cards and medical bills. Medical bills are the most common collections debt, showing up on 43 million credit reports according to the CFPB.
A debt management plan reduces the interest rate and lowers the monthly payment to an affordable number. You make a single monthly payment that covers all the debt detailed in the plan. You will pay the amount you owe, typically in 3-5 years, but under friendlier terms.
The CFPB recommends working with a nonprofit credit counselor, the best of which offer financial education on a debt management plan. It’s often the key component in many successful efforts to manage outstanding debt.
Don’t confuse debt settlement with a DMP. Debt settlement allows you to settle your debt for less than what you owe – often with the help of a third-party agency – but you agree to settle that debt in a lump sum.
Filing for Bankruptcy
Depending on your financial circ*mstances and the amount of debt in collections, filing for bankruptcy could be your best option.
Bankruptcy is a legal proceeding in which a judge and court-appointed trustee examine the assets and liabilities of individuals and businesses who’ve determined they cannot pay their debts.
Bankruptcy is often seen as a last resort, a surrender flag. But in many cases, it’s a strategic alternative that can save people money and provide the fresh start they need.
People who can’t see a clear path to budgeting their way out of debt often weigh debt settlement vs. bankruptcy. There’s not much common ground other than the major dents both will leave on your credit score.
Keep in mind that filing for bankruptcy requires individuals to undergo pre-bankruptcy credit counseling.
So it’s a good idea to make a call to a nonprofit credit counselor as a first step after contact from a collection agency to understand all your options. Even better to do it before your debt gets to collections.
