Debt collection occurs in phases, and although it can seem overwhelming, there are options for relief.
Many people lack financial literacy. They are unsure where their money is going, how to manage it, and how to get themselves out of financial trouble or debt, all of which can have serious and lasting consequences.
"Many debtors ignore requests from [their] debt collector … at their peril," said David Reischer, a bankruptcy attorney and CEO of LegalAdvice.com.
When you ignore your debt, the consequences start to pile up. The bills get bigger, the anxiety sets in and then comes the emotional toll. Debt can lead to bankruptcy, eviction, wage garnishment, foreclosure, repossession, ruined credit scores and broken partnerships.
If you arm yourself with the right knowledge, however, you can tackle the problem head-on. Business.com talked with debt experts, financial advisors and bankruptcy lawyers to find out exactly what happens to your debt – from delinquency, to collections, to repossession – and what you need to do right now to begin working your way out of the red.
What is the debt collection process?
Debt collection is the process of obtaining payment on a past-due account. Types of debt include utility bills, medical credit cards, loans and civil judgments. The multistage debt collection process varies slightly depending on the creditor, but it usually includes phone and mail notices, stoppage of services (if applicable), notifications to credit reporting bureaus, assignment to third-party collection agencies and potential court proceedings. Ignored debt can have a catastrophic result and should be mitigated as soon as possible.
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The debt collection process can begin as soon as a scheduled payment is missed, but it typically takes effect by the time the payment is 30 days past due. Here is a breakdown of the four main stages of the process:
Stage 1: 30 days past due
In this stage, you are behind on your payment. Your lender likely will call, email or send a letter politely reminding you that your payment is past due and should be submitted as soon as possible. The creditor may reach out to credit reporting bureaus to report your account as delinquent.
What you should do: If you know you are going to miss a payment, proactively reach out to your lender. They may be willing to formulate a payment plan to get you back on track. If you do miss your payment without notifying your lender, contact the lender as soon as you realize you missed the payment, and collaborate on a repayment plan. Do not ignore calls and letters. During this stage, you can still easily rectify the situation.
Stage 2: 60 days past due
During this stage, your debt is still with your original lender, but contact will become more aggressive and persistent. The creditor will contact credit reporting bureaus to report your delinquent account if they have not done so already, and you may be accruing penalty fees.
What you should do: It is not too late to contact your lender to work out a payment or hardship plan. Swift, direct contact is your best course of action.
Stage 3: Charge-off status
Now, the debt has been turned over to a collection agency, and your credit report has likely been updated to reflect you are in arrears. The agency will purchase the debt amount for a fraction of the balance due, usually 30% to 35%, said Todd Christensen, a community financial educator and manager at Money Fit. He advised being proactive and cautious. After the collection agency purchases the debt for a portion of the balance due, it may contact you to collect the full balance.
The collection agency "will never tell the consumer that they only paid a fraction of the balance due," Christensen said. "They just notify the consumer of the balance owed and try to collect as much as possible."
What you should do: To avoid a ruined credit score, you should immediately contact your original creditor (e.g., lender, medical office) and try to set up a repayment plan directly with them. This way, Christensen said, the account may be returned from collections and your credit report may be saved. He recommended following these steps once a collection agency contacts you:
- Ask the collection agency to send you verification of your debt in writing. Do not discuss the debt or payment details any further.
- Contact the original creditor immediately, and work with them to set up a monthly repayment plan you can afford.
- Ask the original creditor if they can get the account back from the collection agency so the creditor will not report the delinquency to the consumer reporting agencies and affect your credit rating.
- Make the payments as agreed to the original creditor.
Stage 4: Court
At this point, the collection agency has been unable to contact you and has filed a lawsuit. You will receive a court summons, and you must attend the court date. If you don't, it will mean an automatic win for the collection agency.
In court, the judge can pass a money judgment, with which "a creditor that is serious about collecting a debt can then take that money judgment and record a lien against [your] home, levy funds on a bank account or force the sale of an expensive asset," Reischer said. "A debt collector can execute on the lien and have a marshal or sheriff seize the property and arrange for a public sale from which the creditor is paid out of the proceeds."
What you should do: First and foremost, show up to your court date so that you can dispute the debt. Then, ask the judge if they are willing to oversee the creation of a repayment plan instead of choosing a lien, wage garnishment or sale of an asset.
Other useful steps to take
The steps are pretty clear, but there are other actions to take along the way:
1. Verify, verify, verify.
Know whom you're speaking to. "Never cave to the pressures of a collection call," Christensen said. "If you do not recognize the debt, always ask for verification, and never give your bank information out."
2. Calculate your DTI.
To stay out of debt, Reischer suggested you calculate your monthly debt-to-income (DTI) ratio. Never take on debt with monthly payments that exceed 40% of your monthly income. "A prudent lender will not lend to a borrower when the DTI ratio becomes very high," he said. "But it is the borrower's ultimate responsibility to calculate their own DTI ratio to determine whether they are able to repay a loan."
3. Understand the FDCPA.
The Fair Debt Collection Practices Act protects consumers from excessive contact by collection agencies by outlining when and how often they can contact you.
Christensen recalled a client who was receiving harassing phone calls from a collection agency they didn't know. The agency threatened the client with legal action and personal contact, which turned out to be unsupported claims that violated the FDCPA. That enabled her, together with an attorney, to send a certified letter to the agency demanding it cease all contact.
If you find yourself in debt, remember to stay calm and focus on resolving it as quickly as possible. Doing so may protect your credit score, property and peace of mind.
Debt collection FAQs
What happens to your credit when you don't pay your debt?
Having a past-due account for any length of time can damage your credit, but the severity varies depending on the amount and type of debt, as well as what your score was to begin with.
Several factors determine your credit score. The amount of debt you have accounts for 30% of your overall score. Unpaid debt is especially problematic, as it can lead to higher interest rates (among other things) in future lending situations because lenders will have reduced confidence in the borrower's ability to make timely payments. Accounts in collections will appear on a credit report for seven years plus 180 days from the time the account became delinquent.
How long can a debt collector attempt to collect a debt?
The length of time a creditor may attempt to obtain payment varies depending on where you live and the type of debt being collected. Although the account may appear on a credit report for seven years, the debtor (or its representatives) could continue to solicit reimbursement long after.
The statute of limitations on a debt is the length of time a creditor has to file a lawsuit for past-due accounts. Again, these guidelines vary by location but could range from three to 15 years from the time nonpayment began. The national average is somewhere between three and six years. In some states, the statute of limitations may reset if a person acknowledges a debt and/or makes a partial payment while the account is still in collections.
What is debt settlement, and what are the risks?
Debt settlement is the act of negotiating a lump-sum payment less than the amount of the original deficit in order to "settle" an account. Debt settlements are usually facilitated by for-profit companies that work on the client's behalf to arrange remittance. While debt settlement can be an attractive option, it does come with some risk.
Debt settlement companies typically require you to stop making payments to creditors if you're already doing so. Instead, clients make payments in a designated savings account for up to 36 months, and that account is then used as a settlement. This process can backfire in that it may negatively affect your credit because of nonpayment to your original creditors, who could initiate a separate debt collection action. Also, credit bureaus have an unfavorable view of debt settlements, since the debtor ends up taking a loss on the original debt.
Additionally, many people find it difficult to make regularly scheduled deposits. As a result, they often exit debt settlement programs altogether, thus setting them back further. There's also the risk that the company will be unable to secure a settlement agreement with the original creditor even if the client successfully makes all required payments.
Rachelle Gordon contributed to the writing and reporting in this article. Source interviews were conducted for a previous version of this article.