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The Business of Debt Collection

Original Creditors

The original creditor is the credit card company where you opened an account. (In fact, an original creditor is any lender that initially gave you a loan, but for the purposes of this discussion we'll focus on credit card companies as original creditors.)

You open an account and everything is fine until you fail to make a payment. What happens first? For the first month or two you will see late fees and penalties, and your interest rate is likely to jump to 29% or higher! This is good news for the credit card company. They actually like it when you fall behind because they make more money (in 2009 credit card companies made about $20.5 billion in penalty fees alone).6

However, the credit card companies only profit from your delinquency if you catch up on your payments and pay the penalties and higher interest rate they are now charging on your card. After 2-3 months of non-payment, you are likely to receive a (somewhat) friendly call from your credit card company's call center. You will be reminded that the call may be recorded for "training purposes."

Then they'll ask about the payment you missed. They may ask why you didn't make the payment on time. They may ask other questions. But mainly they will attempt to get you to make the payment, preferably over the phone, immediately. Short of that, they hope to gather information that can be used against you if you continue to stay in default on the account.

You could make the payment over the phone, but that puts an end to our story. Let's assume you don't. What happens next?

Of course they keep calling, and calling. You'll also get notices in the mail. Like the phone calls, the notices will start out friendly, using language like, "Perhaps your payment has already been mailed. If so, thanks!" Then the language will get more serious, and thinly veiled threats will become less veiled and a lot more open. The goal, of course, is to scare and intimidate you into getting your account out of default.

Credit card companies will generally try to collect on an account in default for six months, after which they will charge it off their books as bad debt. The credit card company reports the bad debt as a loss on their financial reports, gets a tax write-off, and will either sell or assign your bad debt to a debt collector (we'll talk about debt collectors in the next section).

Around month three or four, the credit card company may offer you a settlement. Every company has different practices, but, as an example, your credit card issuer may offer to settle the account for 60% of the balance. If you pay them $6,000, they will wipe out your $10,000 debt. They will also report the debt settlement to the credit bureaus as "settled for less than full amount" and are required to file a 1099 form with the IRS showing you had additional "income" that tax year of $4,000.7

Why might the credit card company be willing to settle before the six-month charge-off date? Remember, they probably carry insurance on the debt, they can take a tax write-off, and they can sell the debt to a collection agency. Say the write-off is worth 20% of the amount of the debt and they will receive a 10% insurance settlement, plus they can sell the debt to a debt collector for 10% of its value. Their exposure has been cut to 60% of the value of the total debt. If they can settle with you for 60%, they are just breaking even.

If you have the money to settle your bad debts with the original creditor, making an offer of 40% or more after not paying for about five months isn't a bad strategy. You can experience sizable debt relief and the debt "dies on the vine." You might also be able to have your credit report updated to "paid as agreed" as part of the settlement (much better than "settled for less than full amount") and have any negative credit entries removed. (You can try negotiating and settling your debts yourself after reading our tutorial on debt settlement in the Roadmap section. Alternatively, you can visit our homepage for a referral to a trusted debt settlement professional.)

Note that some original creditors may choose to assign or sell your debt to a collection company earlier than six months after non-payment. Keep that fact in mind, not only if you are considering settling with the original creditor, but also because your rights differ depending on whether you're being contacted by an original creditor or a debt collector (more on this in later sections).

6. New York Times, September 2009
7. Only about 15-20% of those settling accounts actually receive a 1099 for the difference.

> Should I Ask the Original Creditor for Help?