About Collection Accounts

Finding out that a loan, credit card or other account has been sent to a collection agency is never a pleasant experience. Understanding the purpose of collection accounts and how they function can help you manage the situation better.

Function

Collection accounts are accounts set up when a borrower neglects to maintain the terms of repayment on a loan or line of credit. Usually after a bill has not been paid for several months in a row, the account becomes a collection account. The purpose of a collection account is to take more aggressive action to try to collect the payments owed from the borrower. Collection accounts are assigned to either a separate department within a company or a third-party company that specializes in collecting past-due accounts.

Types

There are basically two types of collection accounts. The first type is an in-house collection account, where the status of the loan or other credit is reclassified as collection, but remains with the original creditor. The second type is a third-party collection account, when the original creditor assigns the account to another agency that specializes in collecting bad debt payments from borrowers. Sometimes the third-party agency is simply contracted to attempt to collect the debt, and takes a percentage of the amount collected. In other cases, the third-party agency actually purchases the bad debt from the original creditor and then attempts to collect the payment on their own from the borrower. In this case, once the third-party agency has purchased the debt, it keeps any money it manages to collect from the borrower.

Significance

Collection accounts can have a serious negative impact on an individual's credit score. After several attempts to collect a bad debt, a collection agency will typically report the unpaid balance to the credit bureau. At this point, any time the borrower attempts to get a loan or other credit, the new creditor will be able to see that the borrower has been delinquent on loans in the past. This will affect a person's ability to qualify for credit, and can result in higher interest rates if credit is awarded.

Warning

Some collection agencies have received negative publicity about the practices they employ to attempt to collect bad debts. It has been reported that some collection agencies use unethical practices, scare tactics and even harassment to try to get borrowers to pay up their accounts. Generally, collection agency staff send letters and make phone calls to discuss past due accounts with borrowers, but they should not resort to insulting the borrower, using foul language or making threats. The government created the Fair Debt Collection Practices Act, which outlines what constitutes appropriate behavior on behalf of debt collectors (see Resources below).

Benefits

Collection accounts, when handled in accordance with the law and ethical practices, serve a valuable purpose to lending institutions. Without specialized departments or agencies to focus on collecting these past-due payments, companies would be forced to write off millions of dollars in bad debt each year. By having special staff trained to convince borrowers to pay, they can recoup a portion of what otherwise would have been lost.