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Collecting on Bad Debt:
Lessons from AFP and Telework Programs

In September 2009 NATTAP asked the AFP and Telework listservs to describe their processes for pursuing the collection of bad debts. The intention was to determine if any one approach prevails among the programs, and might be deemed a best practice. This is a summary of input from several programs.

The Problem

Programs, whether lending directly or guaranteeing loans, are often confronted with debts which fall into default. Pursuing the collection of such bad debt is a necessary step to ensure the preservation of capital. Each program has the discretion to decide on its own how, and indeed if, it wishes to pursue collections efforts against debtors, based on their own circumstances and preferences.

NATTAP has found that programs pursue collections in several ways:

  • Using the resources of the program itself to contact defaulted borrowers and pursue repayment.
  • Using the resources of its lending partner to pursue collections.
  • Contracting with a third party collections firm to pursue losses

Through discussion with several loan programs, it was discovered that several key factors play a role in determining the approach that programs take relative to their collections efforts.

Factors Influencing Choice of Method

ACA International provides a list of contacts to clarify state regulations on collections by guarantors. Find your contact here.
Legal Considerations
Collection activities are regulated by both federal and state laws that define both how collections activities can be pursued, as well as who can legally collect on a debt. In some states, a loan guarantor is not permitted to attempt to collect on a defaulted debt. In such situations, a guarantee program may only find itself in a position to collect on a defaulted debt if it takes the loan "in house" and issues a new promissory note as a direct loan from the program.

Federal laws, including the Fair Debt Collection Practices Act regulate methods organizations are able to utilize to collect past due debt. Privacy concerns are addressed in the law, as are several practices that are defined as deceptive in the law.

Lender Involvement
Program managers agree that quick action in response to a missed payment is essential to ensuring a borrower stays current. The nature of the relationship between the AFP/Telework program and its lending partner significantly impacts how that contact is pursued. This is particularly the case with loan guarantee situations.

In some cases (including Michigan, and South Carolina), the lending partner and the loan guarantee program have an agreement requiring the lender to make contact with customers as soon as a payment is missed. Michigan, South Carolina, and other states, the lending partner contacts, and attempt to work with consumers until such time as the loan guarantee is paid by the program per their lender agreement's provisions on curing debt.

At that point, the responsibility for collection shifts to the program itself. A decision can then be made on how to pursue the account further. In states where it is allowed, some guarantors might pursue collections immediately after curing the guarantee. Several programs will take the loan in-house and issue a promissory note of their own. In either case, programs can then attempt to collect using their own resources, or contract with an outside collection agency, as Louisiana, Wisconsin and Washington have done.

Compensating Outside Collection Agencies:
Louisiana - Pays $350/yr for unlimited collections efforts by a third party
Wisconsin - Outsourced collections are done by an attorney at a charge or $800-1000 per claim
Washington - Outside agency is paid 38% of any receipts from collections.

Sample Lender Agreement Text:
Regarding default, LENDER will:
- Provide CBO a Notice of Non Payment within 3 working days of borrower's delinquent loan payment, followed by notifications in intervals of 30 days;
In cases such as Iowas's, the loan program assumes responsibility for contacting borrowers as soon as their payment is late. In order for this to occur, the lender provides timely information to the loan program concerning the payment status of their accounts (see sidebar). If, however, a lender does not pursue such contact on its own, and does not provide the guarantor with timely information about the loans it guarantees, valuable time can be lost.

It is therefore important that lender agreements have a clearly defined set of responsibilities for contacting late payers, covering who will be in touch with borrowers at various stages of the collection effort, and the processes they will, and will not use to as part of the collection effort.

Ensuring Accurate Credit Reporting:
Several loan guarantee programs, including Oklahoma, have noted that their decisions on how to approach the problem of collections have been influenced by a desire to ensure accurate reporting of their borrowers' credit histories. Some have reported dissatisfaction with the fact that in some cases, a borrower's default, and their debt's being paid to the lender as per the guarantee agreement can be inaccurately reflected in the borrower's credit file. In some cases, the defaulted borrower's credit will show a satisfactory repayment of the debt (though the repayment came not from the borrower but the guarantee). Several solutions to this problem have been suggested, including:

  • Ensuring that the lending partner report all payment history, positive and negative to the credit reporting agencies.
  • Ensuring that the lending partner makes a note on the borrowers credit file explaining that the debt was paid by the guarantor.
  • Contracting with a collections agency which will then place a collections record on the borrowers credit file.
  • For direct lenders, reporting repayment history through alternative reporting services, such as Credit Builders Alliance.
As a direct lender, Washington state's loan programs utilize CBA to report on borrower performance. The result is a chance for borrowers to both build their credit, and be held responsible for their repayment.

Maintaining Positive Public Image
Programs have expressed some concern about the potential impact of their efforts to collect past due amounts on the public perception of their organizations. It is clear that a balance must be struck between the desire to ensure the lowest level of loss possible, and the image of the programs as being caring, and interested in helping people. While image control is more easily guaranteed when program staff are themselves conducting the collections efforts, other steps can be taken to prevent negative consequences.

Outsourced collections work, whether conducted by the lending partner or a third party should be done on the basis of a clear set of procedures to be followed. ACA International, the association representing the collections industry, has produced a statement of principle and guidelines for the collection of healthcare debts that may serve as a useful guide.

Any situations that arise outside of the bounds of the agreements should fall to the responsibility of the loan program, which should maintain ultimate control over actions taken by its agents.

In Summary
The process of collecting on overdue debt is an involved process that can be pursued by a program itself, by the lending partner, or in collaboration with a third party source.

The choice of if and how to pursue a collection effort will depend on several factors: legal constraints that may prevent a guarantor from pursuing collections on paid off debts; the nature of the relationship between a program and its lender; the desire to ensure accurate reporting of the debtor's repayment history, and the desire to maintain a positive image of the loan program. Careful consideration of the programs goals and situation is required.

September 2009

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Arlington, VA 22209-1903
Phone: 703/524-6686  Fax: 703/524-6630  TTY: 703/524-6639

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