What is a Collection Agency?

A collection agency is like a consignment shop…

Instead of selling a piece of clothing yourself, you can get a consignment shop to do it for you. You still own the item, but the shop sells it for you in return for a fee. Similarly, creditors who feel they can’t or don’t want to collect debts on their own can hire a collection agency to do it for them, in return for a fee. Creditors can also sell the debt directly to the collection agency at a discount.

When a company lends money or extends credit to someone, it expects the borrower to pay it back. This could be a bank offering a loan, a company issuing a credit card, or a hospital providing care before sending a bill. If the borrower doesn’t repay the debt on time, the creditor will usually attempt to recover the money. After a certain amount of time — generally at least 30 days — the creditor can enlist the help of a collection agency. Since most creditors don’t specialize in recovering debt from borrowers, it can be more efficient for them to turn it over to companies that do.

A creditor can work with a collection agency in two ways:

1. The creditor can hire the agency to help it collect the debt and pay a percentage of any amount recovered.
2. The creditor can sell the debt to an agency, sometimes at a discount. The creditor can package multiple delinquent debts together and sell them as a bundle.

Once the collection agency has the debt, its collectors begin to contact borrowers by phone call, text message, letter, or even by showing up at their homes. If borrowers pay the debt, the agency stops reaching out. If they don’t, the collection agency reports this to credit bureaus, which can further damage their credit scores and affect their ability to take out loans or open credit cards. Collectors may also sue borrowers, and a court may garnish a borrower’s wages to enforce a judgment.

Some debt collectors have used tactics that cross the line. In response, federal lawmakers passed the Fair Debt Collection Practices Act (FDCPA) to regulate the industry in 1977. The FDCPA sets rules for how and when debt collectors can contact borrowers. Debt collectors:

• Can’t call between the hours of 9 p.m. and 8 a.m., unless the borrower set up the call ahead of time.
• Can call you at home or work. However, if you submit a written request that they stop calling you, they have to comply.
• Can’t use abusive or profane language.
• Can’t threaten to harm or arrest you, or to sue unless they actually intend to.
• Can’t discuss your debt with anyone but you and your spouse, in most cases.
• Can’t misrepresent themselves, the amount of debt you owe, or the status of the debt.

It’s important to note that these regulations generally apply only to third-party debt collectors, not to creditors. So if your credit card company enlists the help of a collection agency, the rules apply. If the credit card company is contacting you, the regulations likely do not apply.

Most states have a statute of limitations — usually three to six years — that determines how long a debt collector or creditor has to sue you for payment of debts. However, they might still be able to contact you after this period.

If a collection agency does sue you and you lose, a judge may issue a judgment against you. The court may issue an order allowing your wages or bank account to be garnished in order to pay off the debt.

Having a debt in collections can hurt your credit score. How much of an impact it has depends on your credit score before the debt was sent to collections, how much debt you have, and other factors. In general, the higher your credit score was beforehand, and the more debt you have in collections, the more points you will lose. The type of debt you have could also have an impact — You might see a different effect of credit card debt versus medical debt.

If you have a debt in collections, it can remain on your credit report for seven years plus 180 days, whether or not you paid the debt. During that time, it can have a significant impact on the rest of your finances. Having a low credit score and an unpaid debt on your credit report may make it harder to take out loans and credit cards, and any credit you get will likely have a higher interest rate.

It’s important to keep an eye on your credit reports to make sure they’re accurate. If you notice debt wrongly listed as being in collections, you can dispute the error with the credit bureaus.

When possible, the best course of action is to avoid having debt sent to collection agencies. Sometimes this seems unavoidable, but most creditors are willing to work with borrowers if it means they’ll eventually get their money. They may be able to set up a payment plan that allows you to pay an affordable amount each month. Creditors generally lose money by sending debts to collections, so it’s in their best interest to settle the debt with you directly.

If a creditor does send your debt to a collection agency, try to get as much information as you can. A collector has to send you a validation notice in writing within five days of first contacting you. This notice must state how much you owe, the name of the creditor, and steps to take if you don’t owe part or all of the debt. Read it over to ensure that everything is accurate.

You may also want to brush up on your rights as a consumer. Review federal and state consumer protection laws that set rules for how debt collectors behave. If a debt collector isn’t abiding by regulations, you can file a complaint with the Consumer Financial Protection Bureau or with your state attorney general’s office.

Once the debt is in collections, you have two options:

1. You can pay the debt collector. You can pay the full amount, set up a payment plan, or negotiate to pay a smaller sum. Many borrowers aren’t able to pay the debt in full — If they could, they probably would have already paid it. The good news is that collection agencies usually purchase debts at a discount. So even if they don’t get the full amount from you, they aren’t necessarily losing money. This may make them more inclined to negotiate. Whatever agreement you come to, get it in writing, and get a receipt of your payment.
2. Another option is to dispute the debt, which you might do if you genuinely believe the information is incorrect. You can do this by sending a letter requesting the collector to provide written verification of the debt within 30 days of getting the validation notice. If the agency finds that either the debt is not yours or you’ve already paid it off, it will correct the error and stop contacting you. If it determines you really do owe money, it will send a debt verification letter and resume collection efforts.

While you can dispute the debt, if it is yours, it may be in your best interest to pay it to minimize impacts on your credit score and finances.