Two Approaches to Collecting What You Are Owed
When someone owes you money and will not pay, you have two primary options before going to court: sending a demand letter yourself or hiring a collection agency. Each approach has distinct advantages and drawbacks. The right choice depends on the size of the debt, how much time you have, the debtor's likely response, and your comfort with confrontation.
This guide provides a detailed comparison to help you make an informed decision.
Understanding Demand Letters
A demand letter is a formal written notice sent directly from the creditor to the debtor. It identifies the debt, states the amount owed, sets a payment deadline, and warns of legal consequences if payment is not made.
Costs
The cost of a demand letter depends on who writes it:
- Self-drafted: $5 to $10 (certified mail costs only)
- Online service: $50 to $200 (automated platforms that generate and mail letters)
- Attorney-drafted: $200 to $500 (a lawyer drafts and sends the letter on their letterhead)
Regardless of the method, you keep 100% of whatever the debtor pays.
Success Rates
Demand letters are surprisingly effective. Industry data suggests that a well-crafted demand letter resolves 30% to 50% of disputes without further action. Letters sent on attorney letterhead have higher response rates, with some attorneys reporting that 60% to 70% of their demand letters result in full or partial payment.
Timeline
A demand letter typically sets a payment deadline of 7 to 14 days. From drafting to receiving payment, the process often takes 2 to 4 weeks. If the letter is ignored, you can file in court or escalate to a collection agency.
When Demand Letters Work Best
- The debtor has the ability to pay but has been avoiding or delaying payment
- The debt is clearly documented with a contract or invoice
- The amount is under $10,000
- You want to preserve a business relationship
- You have time to follow up if the letter is ignored
Understanding Collection Agencies
A collection agency is a company that specializes in pursuing debtors on your behalf. You assign the debt to the agency, and they use phone calls, letters, credit reporting, and other methods to pressure the debtor into paying.
Costs
Collection agencies typically work on a contingency basis, charging a percentage of the recovered amount:
- Standard fee: 25% to 35% for debts under 90 days old
- Older debts: 35% to 50% for debts over 90 days old
- Small balances: Some agencies charge higher percentages (40% to 50%) for debts under $1,000
- Flat fee agencies: A few agencies charge a flat fee of $10 to $15 per account rather than a percentage. These typically send letters and make limited phone calls but do not pursue aggressively.
On a $5,000 debt recovered in full, a standard contingency agency would keep $1,250 to $1,750, and you would receive $3,250 to $3,750.
Success Rates
Collection agency success rates vary widely. Industry averages suggest that agencies recover payment on 20% to 30% of accounts placed with them. However, rates depend heavily on the age of the debt, the debtor's financial situation, and the quality of the agency.
Recovery rates decline sharply with age:
- Debts under 90 days old: 70% to 80% recovery rate
- Debts 90 days to 1 year: 30% to 50% recovery rate
- Debts over 1 year: 10% to 25% recovery rate
Timeline
Collection agencies typically begin contact within days of receiving the account. However, the overall process can take months. Most agencies work an account for 6 to 12 months before considering it uncollectible.
When Collection Agencies Work Best
- The debt is over $2,000 and the debtor has identifiable income or assets
- You do not have time to pursue collection yourself
- Previous demand letters have been ignored
- The debtor has moved or is avoiding contact
- You need someone who can report to credit bureaus
Side-by-Side Comparison
Cost
- Demand letter: $5 to $500 upfront; you keep 100% of recovery
- Collection agency: No upfront cost (contingency); you keep 50% to 75% of recovery
For a $3,000 debt, a demand letter costs you $5 to $500 and you keep the full $3,000 if paid. A collection agency costs nothing upfront but keeps $750 to $1,500 of the recovery.
Control
- Demand letter: You control the tone, timing, and follow-up
- Collection agency: The agency controls communications; you have limited oversight of their methods
Relationship Impact
- Demand letter: Less adversarial; preserves the possibility of future business
- Collection agency: More adversarial; effectively ends the business relationship
Legal Compliance
- Demand letter: You are responsible for complying with applicable laws
- Collection agency: The agency is responsible for compliance with the Fair Debt Collection Practices Act and state laws. However, if they violate the law, the debtor may have claims against you as well.
Credit Reporting
- Demand letter: You cannot directly report to credit bureaus unless you subscribe to a credit reporting service
- Collection agency: Most agencies report to all three major credit bureaus, which can significantly motivate payment
Escalation Path
- Demand letter: If ignored, you must decide whether to file suit, hire an agency, or write off the debt
- Collection agency: The agency may refer the account to an attorney for litigation, sometimes at no additional cost to you
The Hybrid Approach: Start With a Demand Letter
For most debts, the optimal strategy is to start with a demand letter and escalate to a collection agency only if necessary. Here is why:
Step 1: Self-Drafted Demand Letter
Send a demand letter yourself. This costs almost nothing and resolves a significant percentage of disputes. Give the debtor 14 days to respond.
Step 2: Attorney-Drafted Demand Letter
If your letter is ignored, have an attorney send a second demand letter on their letterhead. This costs $200 to $500 and often produces a response from debtors who ignored the first letter.
Step 3: Collection Agency or Court
If both letters are ignored, decide between a collection agency and small claims court based on the amount and your circumstances. For debts under $5,000, small claims court is often more cost-effective. For larger debts, a collection agency with litigation capability may be the better choice.
This staged approach maximizes your recovery while minimizing costs.
How to Choose a Collection Agency
If you decide to use a collection agency, evaluate candidates on these criteria:
Licensing and Bonding
Collection agencies must be licensed in the states where they operate. Verify the agency's license with your state's regulatory authority. Bonded agencies provide additional protection.
Fee Structure
Compare contingency rates. Ask about minimum fees, whether you owe anything if the agency does not collect, and whether litigation fees are extra.
Collection Methods
Ask what methods the agency uses: letters, phone calls, credit reporting, skip tracing, and litigation. Agencies that use all available methods are generally more effective.
Compliance History
Check the agency's complaint history with the Consumer Financial Protection Bureau and your state's attorney general. Agencies with numerous complaints may use aggressive tactics that could expose you to liability.
Industry Specialization
Some agencies specialize in specific industries (medical debt, commercial debt, consumer debt). Choose an agency familiar with your type of debt.
Reporting
Ask how often the agency provides status reports and what information is included. You should receive at least monthly updates on collection activity and any payments received.
Legal Considerations
Fair Debt Collection Practices Act (FDCPA)
The FDCPA regulates third-party debt collectors, including collection agencies. Key requirements include:
- Providing a written validation notice within 5 days of first contact
- Not calling before 8 a.m. or after 9 p.m.
- Not using abusive, deceptive, or unfair practices
- Ceasing contact if the debtor requests it in writing
The FDCPA generally does not apply to original creditors collecting their own debts. This means that when you send a demand letter yourself, you have more flexibility (though you must still avoid harassment and deception).
State Collection Laws
Many states have their own collection laws that may be stricter than the FDCPA. Some states regulate original creditors as well as third-party collectors. Check your state's laws before engaging in collection activities.
Potential Liability
If a collection agency you hire violates the law, the debtor may sue both the agency and you. Protect yourself by choosing a reputable, licensed agency and including an indemnification clause in your agreement with the agency.
Specialized Situations
Business-to-Business Debts
B2B debts are often larger and more complex than consumer debts. Demand letters are particularly effective in B2B contexts because businesses value their reputation and want to avoid litigation. Collection agencies that specialize in commercial debt often have lower contingency rates (15% to 30%) and higher recovery rates.
Small Debts Under $500
For very small debts, neither a collection agency nor a lawsuit may be cost-effective. A demand letter is often the only practical option. If the letter is ignored, consider whether the cost of further pursuit justifies the potential recovery.
Debts With Disputed Amounts
If the debtor disputes the amount owed, a demand letter gives you an opportunity to address the dispute directly. Collection agencies are less effective when amounts are disputed because the debtor can request validation, which delays the process.
International Debts
Collecting debts from parties in other countries is significantly more complex. Demand letters can be sent internationally, but enforcement requires navigating the foreign country's legal system. Specialized international collection agencies exist but charge higher fees, often 40% to 60%.
Making the Right Decision for Your Situation
Consider these factors:
- Debt amount under $2,000: Demand letter only. The collection agency's fee makes agency collection uneconomical.
- Debt amount $2,000 to $5,000: Start with a demand letter. If ignored, consider small claims court over a collection agency.
- Debt amount $5,000 to $25,000: Start with a demand letter. If ignored, a collection agency with litigation capability is often the best option.
- Debt amount over $25,000: Consider an attorney-drafted demand letter followed by litigation if necessary. Collection agencies are less effective for very large debts.
- Time available: If you have limited time, a collection agency handles everything. If you can invest a few hours, a demand letter is worth trying first.
- Relationship importance: If you want to preserve the relationship, handle it yourself with a demand letter. Collection agencies burn bridges.
Frequently Asked Questions
Can I send a demand letter after hiring a collection agency?
Generally, no. Once you assign a debt to a collection agency, they handle all communications. Contacting the debtor directly while the agency is working the account can create legal complications.
Do collection agencies sue people?
Some do. Agencies with in-house attorneys or attorney network relationships can file suit on your behalf. This is more common for debts over $5,000. Ask about litigation capability before hiring an agency.
How long should I wait before hiring a collection agency?
The sooner, the better. Recovery rates decline with age. If your demand letter is ignored after 30 days, and you do not plan to file in court yourself, place the debt with an agency promptly.
Can I use both a demand letter and a collection agency for the same debt?
Yes, sequentially. Send a demand letter first. If it is ignored, hire a collection agency. Do not use both simultaneously, as this can confuse the debtor and create legal issues.
What happens if a collection agency cannot collect?
If the agency is unable to collect after their standard work period (usually 6 to 12 months), they will return the account to you. Under a contingency arrangement, you owe nothing if they do not collect. You then have the option to pursue the debt through other means, such as filing a lawsuit, hiring a different agency, or writing off the debt. The statute of limitations continues to run during the time the agency worked the account.
Can I report the debt to credit bureaus myself without a collection agency?
Technically, yes, but the process is not straightforward for individual creditors. You must establish a relationship with the credit bureaus, comply with their reporting requirements, and follow the Fair Credit Reporting Act. Most individual creditors find it easier to have a collection agency handle credit reporting as part of their collection efforts. Some property management platforms and landlord associations offer credit reporting tools designed for small creditors.