Dec 12, 2018 Philip Burgess
For businesses of all sizes, credit serves as an integral part of capital operations and in many ways cannot be avoided. The financial well-being of a company relies on a healthy credit status, both for them and the partners and vendors in their network. And as a result, companies must often take on a good deal of credit risk as part of their operational action plans.
The most effective debt management tool is information, as it allows company owners to stay on top of their credit and anticipate the damage caused by unpaid debt.
The magnitude of credit risk usually corresponds to the scope and size of the organization in question, as the B2B space comes with a unique set of challenges that consumer-facing businesses do not have to contend with (usually). Regardless of the particulars, company owners should have a firm understanding of how credit works and the risks posed by a turbulent credit history.
At one point or another, a company may encounter an unavoidable credit crisis, whether from poor business decisions or partnerships with less-than-legitimate vendors. Whatever the cause, these difficult circumstances can lead to major debt problems if the proper corrections are not made, which in turn may significantly affect an organization's credit score. The best way to keep debt collectors from phoning in is to develop a proactive risk management strategy built on information and insight. But before a successful strategy can be hammered out, it's important to put all the finer details in clear focus.
Traditional credit vs. non-traditional credit
The most effective debt management tool is information, as it allows company owners to stay on top of their credit and anticipate the damage caused by unpaid debt. To that end, it can be useful to review traditional; and non-traditional credit score basics from time to time. According to the Consumer Financial Protection Bureau (CFPB), "credit score predicts how likely you are to pay back a loan on time." The credit scoring system is based on a mathematical formula that helps lenders and creditors avoid fraud and mitigate the massive risk involved with their financial products. Most financial institutions deal in traditional credit, which factors in a range of scoring factors like loan payment history, current unpaid debt, number/type of loan accounts, recent credit applications and more. These criteria are weaved together to help creditors better understand a business's ability to meet its financial obligations, but it doesn't always paint the full picture.
Non-traditional credit histories help to fill in the gaps left by traditional scoring methods, which can support companies with limited or no credit history by demonstrating their financial credibility using alternative sources. Even businesses that maintain a healthy credit score can be left with an incomplete understanding without considering these alternative factors:
- Utility bills (electricity, gas, water, telephone, internet service)
- Housing rental payments
- Medical insurance coverage
- Vehicle insurance payments
- Mobile phone bills
- Life insurance policies
- School tuition payments
Typically, non-traditional credit histories are built from financial obligations that require periodic payments on a regular basis, with intervals no longer than three months between payments. Most lenders and creditors will require remittance information spanning the most recent consecutive 12-month period, though every institution has different eligibility guidelines. Alternative credit is a powerful tool for securing credit lines and loans when traditional methods have failed, though qualifications tend to fluctuate based on the underwriting method and loan product in question.
What causes a credit score to drop?
Because businesses are always engaged in debt accumulation and repayment, credit scores tend to fluctuate over time. Slight variations in credit scores are common, but large or prolonged downturns can be caused by negative items within a report. Some examples include late payments, past foreclosures, lingering bankruptcies and a high volume of new credit applications. It's important to note that overall debt is not necessarily a bad thing, as many businesses deal with a wide range of vendors with varying costs. Businesses typically run into trouble if they fail to pay their bills within 30 days of the due date, which can take a large toll on their credit score if left unresolved. Debt collection agencies don't get involved until debt repayment becomes a habitual problem and even then they're governed by a strict set of guidelines on how they can seek reimbursement.
The role of debt collection agencies
While the particular conditions may vary, debt collectors are usually concerned with one thing: Getting businesses and individuals to pay their overdue or delinquent debts. An unpaid bill is considered "delinquent" when it is at least 60 days past due, which provides a decent amount of time to make a late payment before a debt collection agency gets involved. In most cases, these agencies work as middlemen for a creditor to help secure payment for a range of overdue accounts, including:
- Credit cards
- Medical bills
- Utility bills
- Automobile loans
- Personal loans
- Business loans
- Student loans
The primary method of collection is persistent letter writing and calling, though many agencies are willing to bring legal action against a business or individual that refuses to pay. Some collection agencies also buy debts from creditors, lenders and other businesses, many of which are so old that they no longer appear on credit reports. As every state has different statute of limitations guidelines, the length of time they can pursue an outstanding debt varies. Luckily, there are limitations to how collection agencies can operate. For example, they are not allowed to threaten or harass in the course of their collection work, which is outlined in consumer financial protection laws.
While debt collectors are not allowed to unduly harass debtors, they are allowed to conduct searches and investigations into their assets. Collection agencies often search through bank and brokerage accounts to determine if a business or individual is purposefully concealing an ability to repay a delinquent debt. The agency may report these delinquent debts to credit bureaus in an effort to compel payment, as failure to pay can have serious consequences for a debtor's credit score. Since businesses rely on a healthy credit score to secure long-term financial well-being and profitability, this course of action can be quite persuasive.
How collection agencies affect credit score
While the Fair Debt Collection Practices Act (FDCPA) restricts third-party debt collectors from engaging in harassing behavior, there are several legal alternatives that can negatively impact a business or consumer. One common recourse is to report businesses with longstanding delinquent debts to the credit bureaus, which may limit their ability to secure loans and credit lines in the future. For businesses that rely on credit to cover their operational costs, this course of action has the potential to completely disrupt their finances. With that in mind, it's crucial for company owners to understand the time frames surrounding debt collection and reporting to prevent long-term damage to their business's credit score.
- Most creditors wait 30 days before calling-in a debt collector: Forgetting to pay a bill is common, which is why many creditors offer 30 day grace periods before connecting with a debt collection agency. During that time, representatives usually contact the business to remind them of the overdue bill, giving company owners a fair chance to settle the debt before it's passed along to a collector.
- Debt collection agencies immediately report you to credit bureaus: Unlike creditors, most debt collection agencies offer no waiting period before they take action. Some agencies will reach out before filing a report, but most immediately contact the credit bureaus to make them aware of the delinquent debt. If a company owner is hearing from a debt collector, chances are a report has already been filed.
- Delinquent debts stay with your credit history for seven years: Once an account has been reported to a credit bureau, the delinquent debt is immediately added to the business's credit history. Except for special circumstances, this stage of the process is irreversible. Debts that have been reported as "in collection" normally linger for close to seven years, which can make future credit applications much more difficult.
The collection process can have serious consequences on businesses, as each delinquent account entry in its credit history further reduces the company's credit score. Low credit scores can prevent businesses from securing the credit lines they need to keep operations running, which in some cases can lead to a loss of profitability and even bankruptcy. To such avoid worst case scenarios, businesses should always try to pay their bills on time, stay on track with their credit and create a proactive system for managing credit risk.
How to pay off collection and repair credit
Although debt collection agencies get a lot of flak for the work they do, many are more than willing to help businesses repay their debts. If paying in full is not possible, most agencies will create a payment plan that allows company owners to chip away at their debt through a series of monthly payments. Some are even willing to negotiate a reduced settlement amount, though this option is less common than payment plans. In cases in which collectors are calling about old unpaid debts, it's always important to check the state's statute of limitations and seek legal advice before agreeing to a settlement.
Unfortunately, there are very few options for getting a paid collection or delinquent debt account off a business's credit history without waiting the full seven year period. Sometimes negative items are added to a credit history in error and company owners should immediately dispute the entry if such a mistake is noticed. In some cases, businesses may request a goodwill deletion if their credit report is free of other negative items, but this option is rare and should not be relied upon. The credit repair process is a bit more tangible and involves consistently paying off credit cards and other loans on time over a period of months, even years. As every business has unique operational needs, creating a personalized payment schedule is a great way to avoid further credit score damage. Regardless of the specific nature of a business's credit risks, Microbilt offers specialized enterprise risk assessment and credit risk evaluation tools that can help get things in proper order.
Contact us today for more information about our credit risk management and recovery solutions.