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Home Debt Debt Collection Agencies: How They Work & What You Need to Know

Debt Collection Agencies: How They Work & What You Need to Know

Hand reHand reaching out of phone towards wallet, representing a debt collection agency

At a glance

A debt collection agency is a business that profits from collecting overdue debts.

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Written by Renée Chen and Jessica Norris

Reviewed by Victoria Scanlon and Robert Jellison

Apr 21, 2022

Fresh advice you can trust

We promise to always deliver the best financial advice that we can. Our writers and editors follow strict editorial standards and operate independently from our advertisers and affiliates. Learn more about how we make money.

Being contacted about an overdue debt can be intimidating, especially if you don’t recognize the company that’s calling you.

If you’re in that situation, you might have searched the company’s name and found out they’re a debt collection agency. But what exactly are debt collection agencies, and what are your rights when you’re dealing with them?

Table of Contents

  1. What are debt collection agencies?
  2. Who uses debt collection agencies and why?
  3. What does a debt collection agency do?
  4. How debt collection affects your credit

What are debt collection agencies?

A debt collection agency is a company that collects overdue debts (e.g., credit card debt, unpaid hospital bills, or personal loans). Someone who works for a debt collection agency is called a debt collector.

In many cases, debt collection agencies try to collect on debts that your lender has charged off (written off as a loss) because they no longer believe you’ll pay them. When this happens, your creditor will sell or transfer your debt to one of the major debt collection agencies in the US.

Most creditors don’t send overdue debts to collections right away. When you have a late payment, they’ll initially try to collect the money themselves. They’ll usually wait 3–6 months after your payment due date before enlisting the services of a debt collector. 1

Debt collectors provide two primary services:

  • First-party debt collection
  • Third-party debt collection

First-party vs. third-party debt collection: what’s the difference?

First-party debt collection refers to cases where the company that owns your debt (such as your original creditor) has an internal collection department and uses their own in-house debt collectors to get payments from you.

By contrast, third-party debt collection refers to cases where the owner of your debt hires a separate individual or company to collect the debt on their behalf in exchange for a fee. This will often be a percentage of the money recovered—typically around 25%, according to a respondent in a 2016 study conducted by the Consumer Financial Protection Bureau. 2

Third-party debt collection agencies are often confused with debt buyers, although they aren’t quite the same thing.

What are debt buyers?

Debt buyers are companies that purchase debts from creditors, often for just a small fraction of the original amount owed. For example, a 2013 analysis by the Federal Trade Commission revealed that debt buyers paid an average of 7.9 cents on the dollar for debts less than 3 years old and 2.2 cents on the dollar for debts that were 6 to 15 years old. 3

Some debt buying companies are also debt collection agencies, but not all. In other words, debt buyers may either try to collect debt themselves or hire another third-party debt collection agency to do it for them.

Who uses debt collection agencies and why?

Creditors usually hire third-party debt collection agencies when they think it will be more cost-effective than spending their own time and money trying to get you to pay your debts. 4

Some companies work with debt buyers for the same reason—if they think you’re unlikely to ever pay, they may decide that it’s better to recoup some of their losses by selling the debt.

Here are a few examples of businesses that commonly work with debt collection agencies: 3

  • Medical offices (e.g., clinics and hospitals)
  • Credit card companies
  • Utility providers
  • Phone companies
  • Property management companies
  • Banks and financial services companies
  • Other lenders

In some cases, government agencies also work with debt collection agencies to recover government debts, such as unpaid taxes, parking fines, or other fees.

Types of debt serviced by debt collectors

As you might guess from the list above, the following are examples of debt collection activities might be sent to debt collection agencies:

  • Credit card debt
  • Hospital bills
  • Personal loans
  • Utility bills
  • Student loans
  • Rent payments
  • Overdue tax bills

Debt collectors generally collect unsecured debt, such as debt from unsecured loans or unsecured credit cards.

Lenders are less likely to hire debt collection agencies for secured loans (such as auto loans or mortgages) because they can just use repossession or foreclosure to cover their losses. The exception is if there’s debt left over (known as a deficiency balance) after your lender has sold the asset you used to secure your debt.

What does a debt collection agency do?

Debt collection agencies perform a variety of services, depending on the type of debt they collect and whether they perform first-party or third-party debt collection.

Here are some common things that debt collection agencies do:

  • Make phone calls, send text messages, and mail letters
  • Report to the credit bureaus
  • Track down debtors and their assets
  • File lawsuits against debtors who refuse to pay
  • Negotiate debt settlements and payment plans

However, all debt collectors must abide by the guidelines set out in the Fair Debt Collection Practices Act (FDCPA), which is a federal law designed to protect your rights and prevent debt collectors from engaging in abusive collection practices.

FDCPA restrictions on debt collection agencies

The FDCPA protects you from debt collector harassment by prohibiting debt collectors and debt collection agencies from doing the following: 5

  • Calling you incessantly
  • Calling you at an inconvenient time (by default, assumed to be before 8 am or after 9 pm, your time)
  • Calling your workplace if you tell them you can’t receive calls at work
  • Sending automated calls or prerecorded messages telling you to make payments
  • Misrepresenting the amount you owe
  • Revealing your debt to anyone but you, your spouse, or your parent (if you’re a minor)

Debt collectors can contact other people you know, but they can only do so once per person and only for the purpose of getting your contact information, and they aren’t allowed to share information about your debts.

Moreover, if you ask debt collectors to stop contacting you, they must comply. 5 It’s a myth that there’s a special 11-word phrase for stopping debt collectors—all you need to do is state your request clearly and send it in writing.

How debt collection affects your credit

Debt collection is highly damaging to your credit. Once a collection account appears on your credit report, you’ll probably see a big drop in your credit score. Like most other negative information, collections stay on your credit report for up to 7 years, although their effect diminishes over time. 6

Debt collectors usually report account information to the credit bureaus, which is why you may see collection accounts on your credit report. However, they may wait to report the account in certain cases or refrain from reporting it altogether if they consider your debt to be too small. 2 For example, an unpaid parking ticket might not affect your credit score after going to collections, given how small the fines tend to be.

Some credit scoring models ignore paid collection accounts

Newer versions of the FICO and VantageScore credit scoring models (such as FICO 9, VantageScore 3.0, and VantageScore 4.0) ignore collections that have been paid off, so it’s possible to prevent collections from hurting your credit. However, in older scoring models (which are still widely used), paid collections still lower your credit score. 7 8

Fixing your credit after debt collection

Thankfully, it is possible to rebuild your credit after collections, although it might take a while. Simply paying off your collections won’t always improve your credit, even if you pay in full immediately after the debt is charged off. The collection account also won’t automatically disappear from your credit reports—instead, it will be appear as a “paid collection.”

There are several ways to remove collections from your credit report, such as finding out who your debt collector is and negotiating pay for delete or a goodwill deletion. 9 However, in many cases, the best approach is simply taking steps to fix your credit and practice good credit habits to avoid having more collections in the future.

Takeaway: Negotiate with debt collectors as early on as possible to avoid problems down the line.

  • Debt collectors are individuals or businesses that try to collect overdue payments from people in debt.
  • First-party debt collectors try to recover debts you owe to their own company, whereas third-party debt collectors are hired to collect payments on behalf of another company that owns your debt.
  • Once a collection account appears on your credit report, it’ll cause a drop in your credit score, and the mark will stay on your credit reports for up to seven years.
  • The Fair Debt Collection Practices Act offers you protection by making it illegal for third-party debt collectors to use unethical or unfair methods to collect money from you.
  • Be proactive about monitoring your credit report and working with debt collectors to resolve your outstanding debts.

Article Sources

  1. Federal Deposit Insurance Corporation. "FDIC Law, Regulations, Related Acts" Retrieved January 24, 2022.
  2. Consumer Financial Protection Bureau. "Study of Third-Party Debt Collection Operations" Retrieved January 24, 2022.
  3. Federal Trade Commission. "The Structure and Practices of the Debt Buying Industry" Retrieved January 24, 2022.
  4. Federal Deposit Insurance Corporation. "The Economics of Debt Collection: Enforcement of Consumer Credit Contracts" Retrieved January 24, 2022.
  5. Federal Trade Commission. "Fair Debt Collection Practices Act" Retrieved January 24, 2022.
  6. Federal Trade Commission. "Fair Credit Reporting Act" Retrieved January 24, 2022.
  7. VantageScore. "The impact of medical debt on your credit reports and VantageScore credit scores" Retrieved January 24, 2022.
  8. FICO. "Delivering What Customers Asked for in FICO® Score 9" Retrieved January 24, 2022.
  9. Equifax. "What to Know About Debt Sold to Collection Agencies" Retrieved January 24, 2022.

Renée Chen

View Author

Renée Chen is a credit analyst for FinanceJar. Her work covers credit repair, credit scores, and loans. Before writing for FinanceJar, she worked as a researcher and writer specializing in property insurance. She has a B.A. from Australian National University and an M.A. from the University of Sydney.

Jessica Norris

Credit Cards Editor

View Author

Jessica Ginter-Norris writes for FinanceJar. She has previously worked in academic editing, web content editing, and math e-learning content writing. She continues to be involved in various writing and editing projects as well as doing editorial training with the Chartered Institute of Editing and Proofreading.

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