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The CFPB has reported that debt collection is the second most common complaint type, with nearly 70,000 debt collection complaints sent to companies.
These agencies either purchase debts outright or work on a contingency basis to collect outstanding balances. Their methods and business models impact how much money can be recovered and how quickly it can be recovered.
This blog breaks down the involvement of collection agencies, explains their revenue streams, and walks you through the typical collection process. It also addresses the legal and technological factors influencing their operations, making it a must-read for business owners and financial professionals.
Debt collection agencies typically enter the picture when creditors find that internal collection efforts are no longer effective or cost-efficient. Creditors, such as banks, credit card companies, or service providers, usually attempt to recover overdue payments in-house for a set period, often 30 to 90 days, before escalating the account.
When debts become significantly delinquent or charged-off (generally after 180 days), creditors may either hire a third-party collection agency or sell the debt outright.
Internal collections teams are part of the original creditor’s organization. They usually handle early-stage follow-ups and less risky accounts, focusing on gentle reminders and payment arrangements.
When accounts age and become more challenging to recover, third-party collection agencies are brought in. These agencies operate independently and specialize in managing older, riskier debts, often with more aggressive collection strategies.
Understanding how debts are categorized helps clarify when agencies become involved:
Creditors decide whether to outsource or sell based on factors like debt age, amount, and the debtor’s payment history. Selling debt transfers ownership to the agency, which then collects for its own profit.
With a clear understanding of how agencies become involved, it’s important to explore the different revenue models collection agencies use to make money.
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Understanding how collection agencies work requires knowing the two main revenue models they operate under: debt purchase and traditional debt collection.
In this model, collection agencies buy delinquent debts outright from creditors, often at a steep discount, sometimes just pennies on the dollar. For example, a debt with a face value of $1,000 might be purchased for $50 to $100. After acquiring ownership, the agency collects payments directly from the debtor and keeps all funds recovered as profit.
The risk here is higher, as the agency’s success depends entirely on its ability to collect more than the purchase price. Agencies often focus on older or charged-off accounts where the original creditor has given up.
Here, agencies act on behalf of the original creditor without buying the debt. Instead, they collect payments and receive a percentage of the amount recovered, commonly ranging from 20% to 50%, depending on the debt's age and complexity.
For example, collecting $1,000 might earn the agency between $200 and $500. This model reduces risk for the agency, as payment is tied to actual recovery, and the creditor retains ownership of the debt.
The debt purchase model involves upfront capital and a gamble on collection success, often leading to aggressive collection strategies. Conversely, contingency agencies operate with less financial risk but earn only from successful recoveries. Agencies specializing in large portfolios of charged-off debt typically use the purchase model, while those focusing on newer or less risky accounts prefer the contingency approach.
With the business models clear, let’s examine the step-by-step process collection agencies follow to recover debts.
Also Read: Understanding what happens when your bill is sent to a Debt Collection Agency
Understanding how collection agencies work means knowing the stages they follow to recover debts efficiently while complying with regulations.
Once a debt is assigned or sold to a collection agency, the first step is reaching out to the debtor. Agencies use multiple channels including phone calls, letters, emails, and sometimes digital messaging.
The goal is to notify the debtor of the outstanding balance and encourage repayment. Federal laws, like the FDCPA, limit when and how often agencies can contact debtors to prevent harassment.
If the debtor cannot pay the full amount immediately, agencies often negotiate repayment arrangements. This may involve setting up installment plans or offering settlements for less than the full balance.
Skilled negotiators aim to recover as much as possible while working within the debtor’s financial capabilities. Settlements can be attractive for both parties, agencies get paid faster, and debtors avoid escalating collection actions.
Debt collection agencies commonly report unpaid debts to credit bureaus, which can negatively impact the debtor’s credit score. This reporting motivates timely repayment but must be accurate to comply with credit reporting laws. Agencies are required to update the status when debts are paid or settled.
If collection efforts fail, agencies may escalate by recommending legal action. Creditors can sue debtors, and courts may issue judgments that allow asset garnishment or wage garnishment. Alternatively, some agencies may decide to sell the debt to another buyer to recoup some costs. This step often signals the final stage of collection attempts.
With the detailed collection steps outlined, the next focus is on how these agencies generate revenue and make money.
To understand how collection agencies work, it’s essential to look at how they generate revenue through different payment models and strategies.
Most collection agencies operate on a contingency basis, where they receive a percentage of the debt they successfully recover. This fee typically ranges from 20% to 50%, depending on factors like the age of the debt, complexity, and risk. Older debts or harder-to-collect accounts tend to have higher fees due to increased effort and lower probability of repayment.
Some agencies offer flat-fee services for newer debts or specific collections tasks. These agreements involve a predetermined charge regardless of collection success, often used in early-stage collections. While predictable in cost, flat fees usually provide less aggressive recovery efforts than contingency models.
Debt buyers purchase delinquent accounts outright, often at significant discounts. They then collect the full debt amount to generate profit. This approach carries higher risk but can yield substantial returns if the agency is skilled at recovery. Pricing of debt purchases depends on the debt’s age, type, and expected collectability.
When debts escalate to legal action, agencies may charge additional fees or pass on court costs to clients. Litigation involves expenses like filing fees, attorney costs, and enforcement charges. While legal collections can result in judgments that facilitate asset seizure or wage garnishment, they also increase operational costs and risk.
The profitability of collection agencies also hinges on the volume of debt they manage and their overall recovery rate. Agencies handling large portfolios benefit from economies of scale, while consistent recovery success boosts revenue. However, fluctuating economic conditions and regulatory changes can impact these metrics.
Understanding how agencies earn money sets the stage for examining the broader industry trends and challenges they face today.
Further Read: Key Factors to Consider When Hiring a Debt Collection Agency
To fully understand how collection agencies work, it’s important to consider the current trends and challenges shaping the industry.
The Fair Debt Collection Practices Act (FDCPA) continues to heavily influence agency operations. This federal law restricts unfair, abusive, or deceptive collection practices, requiring agencies to carefully follow communication rules and provide consumer protections.
Non-compliance can lead to lawsuits, fines, and damaged reputations. According to the Consumer Financial Protection Bureau (CFPB), debt collection complaints remain among the top consumer grievances, highlighting the ongoing pressure to maintain compliance.
Collection agencies increasingly adopt technology and AI tools to improve efficiency and accuracy. Automated dialing, predictive analytics, and machine learning models help identify which debts are most likely to be collected and optimize outreach timing.
AI-driven chatbots now handle initial contacts, reducing human labor and improving debtor engagement rates. Industry reports estimate that AI integration can boost collection rates by up to 30%, while also reducing operational costs.
Disputes over debt validity and billing errors create significant hurdles. Agencies must manage increased documentation and verification requests to comply with consumer protection laws like the FDCPA and FCRA (Fair Credit Reporting Act).
This complexity slows collections and requires specialized training. Additionally, heightened consumer awareness and legal scrutiny demand transparent and respectful communication strategies.
Debt volumes and recovery rates fluctuate with economic conditions. During downturns, delinquency rates rise, increasing the workload for collection agencies but often lowering recoveries as debtors face financial hardship.
Conversely, in strong economic periods, agencies see better repayment rates but might encounter less debt volume. Agencies must adapt strategies dynamically, balancing risk and opportunity to maintain profitability.
Understanding these evolving factors offers a clearer picture of how collection agencies operate today and how they must adapt to remain effective and compliant.
Understanding how collection agencies work highlights their dual revenue streams: purchasing debt at discounted rates or earning contingency fees on collected balances. Agencies must comply with federal regulations while using technology and skilled negotiation to optimize recoveries. Understanding these methods helps businesses choose the right partner for collections.
Shepherd Outsourcing Collections provides ethical, client-focused debt recovery services tailored to the unique needs of each business. Their commitment to transparency and regulatory compliance ensures smoother collections and better client peace of mind.
Contact Shepherd Outsourcing Collections and start recovering what’s owed today.
Collection agencies typically receive debts in two ways: they are either hired by creditors on a contingency basis to recover funds, or they purchase the debts outright from creditors at a discounted rate. When purchasing debt, agencies assume ownership and retain any collected amount as profit.
Yes, collection agencies must comply with various federal and state laws, such as the Fair Debt Collection Practices Act (FDCPA). This law outlines rules on how they can communicate with debtors, when they can contact them, and ensures the protection of consumer rights during the collection process.
Collection agencies generally charge a fee based on the debt they collect. This can either be a flat fee or a percentage of the recovered debt, typically ranging from 20% to 50%. The fee varies depending on factors like the age of the debt, the complexity of recovery, and the volume of debt being handled.
Collection agencies usually handle a wide variety of debts, including credit card balances, medical bills, personal loans, auto loans, and utility bills. The debts that are often referred to are typically older or charged-off accounts that are more difficult for the original creditor to recover.
If a collection agency fails to recover the debt, it may choose to stop pursuing it. In some cases, the agency may sell the debt to another collection agency, or it may recommend legal action. If the debt is too old or deemed uncollectible, the agency might decide to write it off, especially in the case of purchased debt.
©2024 by Shepherd Outsourcing.