- Creditors will often negotiate delinquent debt to limit losses.
- Lenders look for signs of financial distress when you fall behind on payments.
- Without collateral, credit card issuers have limited means to collect delinquent debt.
Before granting a loan approval, a creditor will assess the risk of the borrower, aiming to maximize profits and limit losses. In addition to looking at your raw credit score, credit grantors will also take into account many of the individual factors that make up your credit scores such as timely payments, length of credit history, age of your other credit accounts, and any delinquencies or defaults on other credit accounts. When a borrower falls behind in making payments on an account, the value of the account plummets, forcing the creditor to decide on a course of action to cure, collect, or sell the debt.
Credit cards provide limited means of recovering the debt because there is no collateral to seize. Instead, the lender must decide if it will pursue legal action or accept a settlement for less than the full balance owed. Each route involves time, money, and additional risk to the creditor.
When evaluating all options to collect some or all an account, creditors choose litigation as a last resort, due to the very high cost of collection and long recovery period required to perfect a judgment under a wage garnishment plan or lien recovery. Due to these factors, legal recovery of debts many times returns much less than negotiating a reasonable settlement for less than the full amount owed and puts more money back in the creditors’ pocket much sooner.
When deciding which collection action to take, creditors consider the following:
Early Warning Signs of Financial Distress
1) Ability to Pay: Borrowers demonstrate an ability to pay when they make on-time payments, even if it is only the minimum required. Relying on minimum payments for debt reduction can take up to 30 years or more, depending on the balance and the interest rates charged, because most of the payment goes to interest rather than principal reduction. Due to compound interest, the total repayment can become two or three times the original debt.
A financial hardship, such as the loss of a job, reduction of hours, medical issue or disability, fixed income from social security or welfare payments, divorce or death of a spouse preventing a borrower from keeping an account current at the minimum payment level, increases the likelihood that a creditor will negotiate the debt.
2) Utilization of Available Credit: Utilization refers to the revolving balance in relation to the credit limit. For example, a credit line of $10,000 with a revolving balance of $9,000, has a 90% utilization. When credit card balances remain at or near the credit limit, the high level of utilization becomes a red flag.
Lenders often respond to high utilization by lowering the existing credit limit on open accounts and refusing to extend additional credit. High utilization across several accounts can be a warning sign a consumer is experiencing financial stress.
3) The Presence of Delinquency on Other Accounts: Borrowers who face late payments on one account, could soon become delinquent on multiple accounts.
Creditors Seek to Limit Losses
Creditors want to limit account losses when a borrower falls behind on credit card payments. Negotiating the settlement of a debt for less than the full balance owed is one cost-effective way to achieve this goal. It provides the creditor with faster repayment while lowering the cost of collecting the delinquent debt.
Here are a few factors that influence a creditors’ willingness to negotiate a debt:
1) The Presence of a Hardship: A financial hardship can send a borrower who is barely getting by, into delinquency. If the borrower cannot recover quickly, the high cost of default, from late charges to penalty interest, will prevent them from ever catching up the account.
As the ability to pay falters, the creditor becomes more interested in negotiating some payment, even if it means accepting less than the full balance.
2) How Delinquent is the Account? The further an account falls into delinquency, the less value it holds to both the creditor and to a potential debt buyer who may purchase the account once it is charged-off by the original creditor. Pre-charge-off accounts (less than 180 days delinquent) have significantly more value than a post-charge-off account. Therefore, creditors become more motivated to negotiate debt as it reaches charge-off.
3) Other Account Factors Lenders Consider: When choosing the best route to collect on a delinquent debt, creditors also consider the account balance, the assets of the borrower, the state of residence, and the statute of limitations for legal action in that state. Some states allow debt owners to garnish wages or place liens on a borrower’s property, making it easier for a creditor to force payment on the debt.
Lenders have established practices when deciding how to collect delinquent debt. Most debt owners understand the high cost of legal action and prefer to negotiate a settlement based on the above factors. However, if a creditor does file an action to collect a debt, understand, that there is still a very good opportunity to negotiate a settlement for less than the amount owed, but you need to respond promptly to avoid a default judgment being entered against you for the full amount owed.
