If I have a credit card bill that's months over due, I assume my credit is already shot because of the bill being overdue. The bank sent a notice that if I don't respond within a certain amount of time, then it'll be sent to a collection agency. Therefore, would it make financial sense to work out a payment plan with the bank or negotiate a lower balance with the collection agency? I know that both are detrimental to my credit report/score, but which one is worse?
Once the debt is sold to a collection agency, you may have to deal with them. It's likely the bank will give the collector full power to collect the debt, and will write off the debt completely from their books. If you do negotiate with the bank and send them payment after that, the collector may not credit it to the amount they can collect from you.
I know that both are detrimental to my credit report/score, but which one is worse?
That's like asking if I should shoot you in the arm or the leg. If you have any means to pay the debt, I would negotiate with the bank immediately. You may not be able to get them down to any less than the principal owed (though it can't hurt to try), but you might be able to get the interest and fees waived if you can pay it all now.
There are a lot of factors in play here such as your credit score, history with the lender, current market conditions, etc. But in general, it is best to try to work with the original lender; preferably before it goes into default and to a collections agency.
It does fluctuate from case to case, but even credit card companies will often negotiate to settle a credit card account in full if you are falling behind.
The one time I had to do it, back in 2008, I think I paid about 65-70% of a low five figure amount. They can also offer you payment plans which may (or may not) still accrue interest, but won't do anywhere near as much damage to your credit score.
I know sometimes it is scary or embarrassing, but truly the worst thing you can do is ignore the debt and not open a line of communication with the lender. They have tools in place to help customers that have hit a rough patch.
There are two types of "at a collection agency".
- the bank still owns the debt, but has subcontracted to a collection agency to do the dirty-work of sending nasty-grams and blowing up your phone and generally scare you into paying.
- The bank has finally given up on collecting the debt, and sold the debt off for pennies on the dollar. The agency now owns it, so you owe them.
You can negotiate a lot, but once the debt is sold, you can no longer negotiate with the bank, as you have nothing they want.
If you continue or resume making regular payments to the bank, they will likely not sell your debt.
Your credit report
A bad debt will appear on your credit report for 7 years after the last activity. The trick is, if you are making regular payments, that is activity. The irony is continuing to pay it off will make your credit score worse. If you pay it in full, it will say so, but will still say how late you were to pay, so it still does the bulk of the damage.
The lateness score bottoms out at about 150 days late. Less than 30 days late is not reported.
Now if it's with the original bank, you might be able to negotiate removal of that adverse credit reporting in exchange for a full payoff. You won't have any negotiating power once you've paid it off though.
It's better to negotiate a settlement with the original lender, both for your credit score and for your pocketbook.
Regarding your Credit Score:
If your credit is already heavily impacted from a host of other late payments, delinquencies, or charged off accounts, then the difference to your credit score between catching up a delinquent account vs a charged off account will not be that significant.
Even if this is your first brush with delinquency, going from delinquent to charged-off will not have as big an impact on your score as you may expect, because most of the damage has already been done by missing payments. Charge-offs are definitely worth avoiding, as they linger for 7-years on your credit history, but their impact diminishes significantly after a couple years.
As for your pocketbook:
Charging off an account is not when the bank sells your account to a third party, it's when they deem it to no longer be an asset (typically after 180 days of non-payment). They may immediately sell your charged off account, but they still might try to collect before selling the debt. Regardless, at this point, the real value of the account is a small fraction of the account's original value, it's better for them to strike a deal with you than to sell it to a third-party. It's also better for you, because you can avoid a charge-off on your credit score, and you can often strike a better deal with the original lender.
Here is a great article: How to Settle Credit Card Debt Quickly.
Edit: This answer assumes that your goal is to pay debts and protect credit score as much as possible. If you cared about neither, and depending on your circumstances, bankruptcy could be better for your pocketbook.