How do collection agencies work

Question

I wanted to understand how companies decide to send accounts of customers to collections and then, how the collection agencies settle.

My understanding was that in any company, that has receivables, will have:

i. the internal accounting department contact the customer for payment of their outstanding account balance(s)

ii. there could be some "wiggle room" for the customer to get a discount on the above outstanding account balance(s) as the internal accounting department will try to settle the payment without sending it to collections

iii. only when the customer fails to pay atleast 30 - 50% of their outstanding account balance(s) will the internal accounting department send accounts of such customers to collections

My understanding of the concept of collections in this case is: the internal accounting department literally sells off the debt at a discounted price (typically 30 - 50% of the face value) to the collections agency.

It then becomes the job of the collections agency to recover any money from the debt.

1. Can the company, that sold off the debt to the the collections agency, claim the face value as a loss and write it off completely? (Or do they only get to claim the 70 - 50% of the face value as a loss and write it off)

2. Why would a company want to send to an account to collections without trying to contact the customer for payment of their outstanding account balance(s) at all?

3. Why would a collections agency not take the money offered to them by the customer and report a customer to the credit bureaus instead when the customer was willing to pay them 50% of the face value? Isn't that a loss to the collections agency?

There are two stories for background that lead me to ask these questions (feel free to skip over these, but would give some context):

1. I am helping out a freshman international student who just arrived in the U.S. last Fall. A few days after his arrival, he fell sick and went to the nearest hospital.

   After his recovery, he got a bill from the hospital for around $4000. The international student health insurance that he bought refused to cover any of it as the T&C mentions that he has to visit his on-campus medical center first in such non-emergency cases.

   He appealed to the insurance company noting that the nearest hospital was within walking distance and visiting the on-campus medical center would have required him to drive, for which he had no license yet.

   This went back and forth for 2 months and the insurance company agreed to pay 40%.

   When this student sends the check to the hospital, he gets a notice a few weeks later notifying that he has been sent to collections already!

   The only communication from the hospital since they handed him the bill had been a courtesy call asking him whether he would like to pay the bill by credit card, check or draft. There was never any talk of late payment or a warning that it would be sent to collections.

   Last day, on contacting the collections agency, they are asking for 140% of the bill amount, tacking on the additional 40% as various fees.

   I personally contacted them on the students behalf, offered to pay them upto 70% of the bill amount and these guys are unflinching. It's either what they want or they will trash the credit report!

   Hence, my question #3

2. I was involved in an incident with a rental car agency where the agency charged an obscene amount of money for a very minor repair (How would a collection against me affect my credit).

   After some research, I found out that a resonable repair would typically cost $300 instead of the $1600 they billed.

   I offered $600 to the rental car agency, they agreed to settle for $950.

   I was confident that they would be willing to settle for ~30% of the original $1600, and was thinking of pushing this down further to $600

   However, after the incident last day, I am not so confident, and am really afraid this might not end well and I might be reported to a collections agency without me knowing or in the loop!

   Hence, my questions #1-3

In the end, what I am trying to figure out is how paying off debt through collection agencies would affect my credit report, provided I reach a full settlement agreement with them.

Answer 1

The short answer to all of this is that it depends on the loan and on the collections agency.

It's an "interesting" time to be a collections agency right now. On the one hand, people are defaulting on debts, and those creditors want to be paid and are beating down the agencies' doors. On the other hand, if you can't pay you can't pay, and the threat of collections action is not much of a motivation when you're already 90 days out, and so collections agencies are having to consult crystal balls and tea leaves to try to determine which debts they're likely to collect if they buy.

Many collections agencies have begun subscribing to the "you catch more flies with honey than vinegar" philosophy; "we know it may be very difficult for you right now, so we'll make you a deal to settle the debt for 80% of face value, and you'll never hear from us again". Other agencies continue to live by the threat model; "we're heartless and cruel and we don't care that it's tough; we own you and you will pay us everything we ask for or we will make your life hell every way we can".

There are advantages, and a certain synergy, to both approaches. You really do get more success by making a deal, so the agency that is willing to work with the debtor and offer them a good deal is going to be more likely to collect. However, that quickly becomes an incentive to not pay; "Yeah, they sent me this outrageous bill for my sprained ankle, so I just ignored it and let 'em sweat, and ended up paying half what they billed me". Sprinkle in just a few cases of "Yeah, I couldn't pay my cell phone bill so I just let them cut it off, but the collections agency started calling and mailing me every day and I had to pay twice what I owed in the first place to make it stop", which filters through the collective psyche of the masses, and all of a sudden if and when they do offer a deal on a debt you fell behind on, you jump on it.

Now, to the question at the end of your post. It's always better for your credit to pay than to not pay. An open collections account on your credit score will always be a bigger ding than a closed one. But, open or closed, that collections activity remains part of your history unless the collections agency agrees to retract it. Even then, you may have to go around to the big three credit bureaus and get the account removed, using documentation which the agency must provide stating something to the effect of "we agree that this never happened".

If the agency refuses to remove this black mark, how black it will be depends on the terms by which the account was settled. The reporting agencies will be told the face value of the debt that was sent to collections, and they will be told the amount paid to settle it. If the debt was settled for face value, that tells people reading your report that, well, you were very late and only paid under duress, but at least you did make good on the debt in full. If you settle for less than the face value, that says something different entirely; not only could you not pay the original creditor, you had to negotiate to reduce the amount to pay the debt collector. That makes extending you credit very risky; not only are you a proven risk for being late to pay, not only are you a proven risk for them having to write off the debt, but if and when they sell it to a collections agency, the agency will see that a past debt was settled for less than face value and assume they'll get the same treatment, and so will offer less to buy the debt.

Both of those cases are still better than an open collection; that says to someone considering loaning you money that not only will you default, not only will they have to write it off, not only will the collections agency make less profit... the collections agency is unlikely to see ANYTHING from this bad debt and may not even agree to buy it.

Answer 2

1. The company that sold of the debt, does write off the loan [and books loss on balance sheet]. Depending on the Company's policy the amount written of as loss varies. Some Companies only show loss on Principal for the outstanding period [The interest income and charges is not booked]. Some companies would show loss on Principal and the accrued unpaid interest ... So if the total outstanding is say 10,000 and it was sold to collector at say 3,000/- the balance 7,000 is written off as loss.

2. There are multiple reasons, one they don't have time or there are only few cases. But most of the times when on initial delay in payment, it goes to a collection agency for follow-up [and the loan is not actually sold]. The agency gets a commission [around 10-15%] for every successful payment they recover.... its only after some period it actually gets sold completely to the agency for a heavy discount price. Often at 10% the actual value.

3. The collection agency works on threat technique, if they get 50% of face value, they may loss that threat perception and everyone would not pay even if they can ... so it makes more sense for them to get 200% of face value [added interest, charges and other stuff] from one customer rather than get 50% from 4 customers ...

Answer 3

To first understand exactly how collection agencies work it is important to know the background of the industry. The industry started shortly after the great depression. consumers were no longer able to pay for their accounts and companies did not know how to collect. As far-fetched as it seems one of the booming industries was the mafia. Pa and ma shops were paying for protection; some because they were not given a choice. Since the "protection" industry was doing well some of the "employees" (for lack of better terms) had the idea of collecting debt from the companies that were not getting paid. Sears, Macy's and several other creditors decided to sell the unpaid debt to these collectors. Remember, during this era there was no FDCPA to protect consumers. The FDCPA was actually created because the mafia collectors were going door to door to collect and they were not nice about it.

In the meantime there was another industry (for lack of better words) rapidly expanding around the eastern part of the U.S. - none other than the mafia. Did the Godfather go and introduce himself and make a sales pitch to Sears offering to collect monies due to them? Not hardly. But as with any business, ideas were made and created that spurred from the main ideology of the original business. Associates of the mafia marketed to the stores such as Sears and offered to collect the past due debt. The big sell on this.. creditors did not have to pay for the services - the customer did. Originally this “protection” industry was all about protecting the small ma and pop shops for a fee but this time ma and pa did not have to pay - the debtor did. The idea of collecting past due debts spread like wildfire. It was easy money and there was nothing illegal about it. The actual idea behind collecting past due debt from creditors was genius. It was a legit, collectable debt… for a price.

This is why and how the FDCPA was created. So when you deal with a third party collection agency you need to know that you are dealing with the dirtiest of dirtiest people. The people that are hired as debt collectors are your typical ex-felons. There is a reason for this. The good news is now there are laws put into place to protect your rights and your safety.

Agencies purchase what is called "paper". There is "good" and "bad" paper. Good paper are accounts just sold from the original creditor. This includes all good information on the debtor such as phone number, address etc. Sometimes the debt is collected and sometimes not. Either way it is common for a collection agency to resell the paper to another collection agency. This is called 3rd placement.