Dear Credit Score Report,

When a debt collection agency has your closed credit card account, can they charge accrued interest on the account? I have an annual statement from a debt collector indicating that they are applying all of my payment toward the interest and none of the payment is applied to the principal. So in reality, I will never get it paid off! Can you give me some guidance? 

-- Ellen

Hey Ellen,

The debt collection agency certainly can charge you interest. That's because without any rules spelled out in your card account contract or state laws in place to prevent those charges, debt collectors are free to charge interest on closed accounts.

According to experts, without anything to stop them, the collection agency may decide to charge you interest. "The contract between the consumer and the credit card company, and state law will determine whether a collection agency can charge interest on a closed credit account," says Valerie Hayes, general counsel for collection industry trade association ACA International, the Association of Credit and Collection Professionals. Hayes explains that if neither the contract nor the law prevents interest from being charged on a closed account -- or if they don't say anything about it one way or the other -- then the collection agency is free to charge interest to delinquent borrowers. That appears to be the end result you're experiencing. The agency can also report that collection item to the credit bureaus for inclusion on your credit reports , which could hurt your chances to get loans, insurance or even a job. That's good reason to address that unpaid debt.

So how much can you expect to pay in interest charges? It also depends on both your card contract and state law. "If there is no interest rate stipulated in the contract, then state law sets a maximum interest rate a collector can charge," says Joe Ridout, consumer services manager with the nonprofit advocacy group Consumer Action.  He says those maximums can vary by state, with Texas setting the limit at 6 percent -- which Ridout says is one of the nation's lowest -- to California at 10 percent to New Mexico at 15 percent -- which Ridout says is one of the worst for consumers.  In Indiana, which was listed in the address on your email signature, it's 8 percent.   

However, your card contract trumps state law. Ridout says collectors can charge the applicable interest rate listed in a cardholder's contract, regardless of whether that rate is higher that the state maximum. Since card contract always spell out those penalty interest rates, Ridout says the state maximum shouldn't ever set the limit on interest charges for delinquent credit card debt.  

Therefore, to determine the amount you will pay, locate and review your contract, sometimes referred to as your card member agreement. You should have received your contract -- which lists your card's terms and conditions, as well as any penalties for violating those terms -- when you first received your plastic in the mail. Don't know where that contract is anymore? Don't worry: CreditCards.com has a chart that links to the online agreements from major U.S. card issuers. Once you've found yours, look for the "penalty rate," since "that's what the collectors get to use as the max," Ridout says.    

If you confirm the collection agency is within its rights to charge you interest on that closed account, you'll need to work with them to eventually pay off that principal. ACA International says you should ask the debt collectors about setting up an alternative payment plan. Otherwise, you can find out the amount you'd need to pay every month in order to both pay down the interest and begin paying off the principle. That number could provide a wake-up call, since you'll probably need to free up some cash in your budget in order to make bigger monthly payments.

Consumer Action's Ridout suggests a different approach. "I think the most appropriate guidance for someone in Ellen's situation is that she should be aware that, once a bill is in the hands of a collector you have an opportunity to settle the debt for less than the full amount if you can gather up the funds to make a one-time payment," he says. Since the debt collector has probably bought your unpaid debt for less than 50 cents on the dollar, "they are often willing to make a settlement for less than the full amount of the debt (and much less if it's a couple years old), provided that you are a good negotiator," Ridout says in an email. While you're at it, ask that the agency agree to delete that collection item from your credit report (what's known as a "pay for deletion") when you make that lump sum payment. "It's not a 'right' -- and many collectors will not agree to a pay for delete -- but many others will if you can negotiate well," Ridout says. 

"Of course, you should get any settlement offer from the collection company in writing, since collection agents should not be trusted to comply with verbal promises," Ridout says.

And perhaps that the lesson for today's column: If something isn't in writing, you can expect the worst.

Good luck!

--Jeremy 

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