A creditor is a financial institution that extends credit by lending money that must be repaid in the future. There are many types of creditors, from banks and finance companies to family and friends who may offer loans. Entities like cell phone and utility companies or medical offices can also be considered creditors, because they extend services before payment is required. If any of these creditors are not repaid in a timely manner (with the exception of debts owed to family or friends), debt can become delinquent. Delinquent debt refers to unpaid debt, and it varies in severity and consequences based on the amount of time it remains outstanding.
If a loan is secured by an asset, like the borrower’s home or car, the financial institution could repossess that collateral to recoup the missing payments. If a loan is not secured by an asset, the delinquent account might be passed from the issuing creditor to another company that will help them try to collect the money owed. (Read more about secured debts and unsecured debts) Third-party companies that become involved with debt collection are known as either debt buyers or collection agencies.
As illustrated above, debt collection duties can pass from the issuing creditor to either a debt buyer or collection agency. A debt buyer purchases delinquent debt accounts from the issuing creditor for pennies per dollar of debt, which benefits the issuing creditor by helping them recoup some money from accounts that are unlikely to repay. The debt buyer also benefits from the arrangement because they now own the debt, so they keep any money collected for repayment. A collection agency, in contrast, works for the issuing creditor; rather than taking ownership of the debt, the collection agency keeps a percentage of any amount it collects and returns the remaining money to the issuing creditor. A debt buyer may also choose to hire a collection agency after purchasing debt from an issuing creditor.
Debt buyers and collection agencies have a poor reputation for hassling consumers, but there are laws in place to keep them from being unreasonable and dishonest. The Fair Debt Collection Practices Act (FDCPA) prevents certain tactics that include pretending to work for the government, threatening to have you arrested, calling you outside the hours of 8 AM to 9 PM without your permission, and more.
If you require a loan for any reason (a mortgage, car, medical expense, wedding, etc.), the borrowed money is usually accompanied by interest payments. The annual percentage rate (APR) of a loan is expressed as a percentage, and it’s how the issuing creditor makes money. The advantage of taking out a loan from a creditor is that you’ll receive the money you need. The disadvantage is that you’ll pay to borrow, so a lower interest rate is always preferable. Interest rates are based on creditworthiness, so a high credit score usually results in a lower interest rate—since the loan is low-risk for the creditor. Because a poor credit score signifies a higher risk of non-repayment, a loan to an individual with a poor credit score will most likely come with a higher interest rate.
If you ever cannot repay your debt, the collections process begins. If the issuing creditor is unable to collect your repayment, you’ll be contacted by either a debt buyer or collection agency by phone and by mail. These third parties may report your delinquent debt to the credit bureaus, since bad debt can damage your credit score. Bad debt remains on your credit report for up to seven years, so this applies extra pressure to repay the loan. You may also face lawsuits if you refuse to repay your debt, as long as it falls within the statute of limitations (which varies by state and by debt type).
Many debt buyers and collection agencies are willing to negotiate debt repayment. If you’re able to offer a lump sum payment, they may be more likely to settle for less than the total amount owed. If you agree to any new terms, be sure to have the settlement agreement sent to you in writing before beginning your repayment.
If you find yourself faced with debt collection, becoming familiar with your rights is a critical first step. It may also be beneficial to look at your finances and discover why your debt became unmanageable in the first place. Creating a budget could help you avoid mistakes in the future by creating a solid, financial foundation.
If you need help communicating with your credit issuer, Kredit can help.