In our previous article, Introduction to Debt Settlement, we covered what settlement is. Now, it’s important to discuss the why. Why is debt settlement an option that’s available to you and what’s in it for the banks? The more you understand the basics of settling, the better you will know if debt settlement is going to work for you.
NOTE: This post is part of our Debt Settlement Guide. If you’ve missed any of the previous content, or would like to start at the beginning, please see the links at the bottom of this page.
So why is it that banks are willing to accept less than what you owe them? Won’t they go out of business if too many people just quit paying on their credit cards?
Not in the least.
Before a bank makes a loan, or extends a credit card, it knows that a small percentage of accounts will go unpaid. They are expecting it before it happens. When you stop paying your credit card, the bank sees you as a statistic. And the more you understand what banks have set up in order to handle the statistical certainty that not everyone will repay their debt, the more you will see that you have opportunities to resolve debts and recover from financial setbacks sooner than you may think.
There is a multi-billion dollar industry built around the known fact that not all debts can be paid. This collection process begins with your lenders effort to “lose the least”. The tools and mechanisms in place for this effort are, by and large, predictable. And it is the preset and predictable collection procedures that banks, and debt collectors use, that enable you to prepare for settling your credit card debt after you have not made a payment for some time.
The Many Debt Recovery Pipelines
Once an account becomes seriously delinquent, the odds of ever being paid another penny on it decrease dramatically. Creditors have the option of accepting less than the balance in satisfaction of the entire debt (settling), or to drop the account into the collection pipeline and see what they get on the other end. This pipeline consists of 3 options – assign, sue or sell.
I could write several chapters on each of these collection pipelines, but the purpose of this post is to focus on the math your original creditor has to work with when you are unable to pay them.
Your banks have statistical data showing them that only 1 out of 5 of their accounts that go unpaid for more than 90 days will ever get paid. That means about 80 percent of debts they drop into their collection pipeline are not going to result in any form of payment.
The fact that banks typically only collect on 20 percent of accounts that default is one aspect that guides their internal collection and recovery goals. Being forced by our nations accounting rules to charge off your debt is another.
Before I get too much further into how your banks settle debt directly with you, let me briefly outline more of the collection pipeline. This is going to further help you understand why many banks provide you an opportunity to settle with them directly.
Assigning Your Debt to a Collection Agency
Assignment collectors are collection agencies who, on behalf of the creditor, are attempting to collect on unpaid balances. Generally, whatever they collect, they are paid a percentage. Credit card issuers will grade the performance of those they assign debt to, and will continually award collection files to the best performers, the companies who get them the most money.
Assignment of debt also has different tiers. You may be contacted by one debt collection company for a few months, then a different one after 90 days, and even another one 90 days after that. Your account can bounce from one debt collection agency to another for several years.
The collector’s job is to get as much as they can for their client, the bank, and to secure the best return for themselves on their performance-based fee. Assuming the collector is able to collect 50%, the creditor may see a return of as much as 35% of the assigned credit card collection balance. This number is a moving target, and will likely be different per account, per portfolio, per tier, per creditor, and can often change based on which collection agency has your account.
Contingency debt collectors – those who get paid only when they get you to pay – are the most common to have to deal with. Some debt collection agencies are large, and others small. How settlements get negotiated with these debt collectors is also largely predictable.
Being Sued to Collect Your Credit Card Debt
Creditors select accounts for referral to law firms in order to collect. Some law firms’ collection attempts will be very similar to an assignment debt collector, where the firm is paid a performance fee just like a collection agency. Others may start off with that appearance, but will then begin the legal process in order to collect.
Attorneys who sue in order to collect will generally add legal fees to the final judgment amount. Most lawsuits for unpaid credit card debt go uncontested and default judgment is entered against the debtor. The judgment itself is a piece of paper, but with legal enforcement implications, which allow for collection of the debt via property lien, bank account levy and wage garnishment.
Being sued in order to collect has its own costs that will vary, with no guarantee the judgment can be collected on. For your creditor, this means higher costs with an unknown return (rest assured the return as an aggregate justifies the expense enough to keep this part of the pipeline in tact-otherwise it would no longer be supported).
Your Credit Card Account is Sold to a Debt Buyer
There are different tiers of debt sales. Your account can be sold several times and will have a different value at each sale. I want to focus on the sale done by the original creditor, who you opened your credit card account with.
Years ago, while attending a collection industry seminar, I sat down briefly with a VP of risk management for the now defunct WAMU. He told me, at that time, WAMU was catching bids of 15 cents on the dollar for freshly charged-off debt (that number was consistent with the daily updates I was seeing from industry newsletters I receive). That time frame represents some of the highest prices banks could fetch for portfolios of charged off credit cards.
Charge-off generally means the creditor is no longer expecting to be paid and is recording the debt amount as a loss. Banks are obligated to move your account from their asset column, over to their loss column, and no later than a prescribed period. This time frame will often look to you like 6 or 7 months of missing your payments. Credit cards can be charged off earlier than that, but it is not typical, and for the reasons I point out in this article about why your account getting charged off is important to settling for less. Be sure to read that so you understand that your bank charging off your debt does not change the fact that you still owe it.
When your account is purchased, some debt buyers will then subject the accounts it purchased to the same assign, sue, or sell (now re-sell) principle described above. Some of the larger debt buyers, like Midland Funding and Portfolio Recovery Associates, have their own debt collectors on staff.
These buyers risk their capital with an expectation that they will be profitable by collecting on enough of the bad debts they purchase.
Historically, the percentage of non-performing credit cards has been low, less than 5%. During the recession that number skyrocketed to all time highs. Default on mortgage debt, commercial debt, revolving unsecured consumer debt (credit cards) all approached, or surpassed, any prior precedent. Debt defaults have now slowed in pace when it comes to credit cards, but have picked up in other lending segments, like student loans and auto loans.
Focusing on unsecured credit card debt; how has all this affected your ability to settle a credit card with your bank? Well, look at the math. Your creditor will often “lose the least” by reaching agreements with those in serious delinquency before they drop your account into the collection pipeline. This is why debt settlement works, whether 15 years ago, or today.
When it comes to credit card portfolio losses, banks would prefer to work with you in order to lose the least. Someone whose financial situation suggests settling credit card debt is a good option to pursue, and can work directly with their bank, will often be in the position to save the most. Having said that, there are times where you will get a better settlement by negotiating with a contingency debt collection agency that first gets your account. If you want to run your situation by me so I can help you understand how much you can save, fill in the “talk to Michael” form in the right column and I can review your accounts with you.
Banks settle debt for less than you owe, and that’s clearly in their best interests. Many banks are not all that obvious about it until you are past the 90 day late mark (sometimes not until the 6 month late mark).
Our debt settlement guide is designed to help you at an individual level so that you can use debt negotiation to get out of debt in the quickest way possible.
Let’s move on in the debt settlement guide to credit cards and other Types of Accounts to Include in Your Debt Settlement Plan.
If you have a question or concern about how your banks settle debt with you, post in the comments below for feedback. Be sure to include the name of the bank you are dealing with, the amount owed, and how long it has been since you last made a payment. If you would prefer to talk on the phone you can reach me at 800-939-8357, ext 2.
This Debt Settlement Guide includes:
An Expert Guide to Credit Card Debt Settlement
How and Why Banks Settle Credit Card Debt with You (you are here)
Types of Accounts to Include in Your Debt Settlement Plan
Why Settling Credit Card Debt is Like a Race
How to Settle Credit Card Debt Quickly
How to Talk to a Debt Collector
How to Negotiate Credit Card Debt Successfully Yourself
7 Largest Credit Card Banks and How They Settle Debt
Get Debt Settlement Letters and Agreements from Collectors
Paying Debt Collectors After You Negotiated a Settlement