In the credit world, once a company has exhausted its attempts to get timely payment, they turn to collections, the process of trying to settle debts through direct appeal, garnishment, or legal action. Don’t fall for the myth of believing that credit card companies “enjoy” turning an account over for collection. Once that step is taken, they get only a fraction—pennies on the dollar—if anything. It is a last resort.

It’s ironic that many people are so resentful of their lenders (mortgage lenders, credit card companies, finance companies) that they become self-destructive. A dispute over whether or not you owe the debt itself should not be resolved by cutting off communication or by automatically allowing the account to go to collection. Once that happens, your credit rating will fall precipitously, and it will take years to recover. Meanwhile, you might not get that mortgage loan you need. Poor credit may even affect your ability to get a better job.

I had three choices. I could have been “right” and stubbornly refused to pay these charges. After all, they really belonged to my ex—not to me. But losing out on the opportunity to refinance would have cost me $350 per month in extra interest, $4,200 per year, and $21,000 over five years. Extending that out for a 30-year mortgage, the cost of “being right” would potentially cost me $126,000, originating from a $362 collection.

Rationally, refusing to pay the bill would be financial suicide, but I completely understand why many people make this choice, even years after a divorce. Upon discovering issues like this, it brings up all of the past anger. Doing nothing would have satisfied my “need to be right,” but it would have been an expensive choice.

A second choice would have been to just pay the charges and be done with it—but would I be done with it? Once you pay off charges showing up as past due, you will find it next to impossible to get them removed from your credit report. For this reason, I took the third—and best—choice available. I negotiated.

Before you pay off the charges, you must negotiate removal of the negative item from your credit report, to take place as soon as you make the payment. Get this in writing. Don’t trust the word of an anonymous clerk you talk to on the phone. Your letter should promise to immediately remove the delinquent mark upon payment of the entire bill. I made this deal, paid the $362, and cleaned up my credit reports. Eventually, I was able to get my refinance and lower my monthly mortgage payments. My own experience makes an important point: You can be right, literally, and still suffer due to a stubborn insistence that you are not going to pay a bill. Many a righteous person has gone to the financial gallows for this position.

What about those cases in which a negative item (like a delinquent payment or an outstanding account) you’ve never even heard of shows up? If you are not even sure you owe the money or were late on the payment, don’t shrug it off. Take three verification steps right away:

Some people play a little game of cat-and mouse with their debts, opening bank accounts in other people’s name and taking jobs that pay cash under the table. Disappearing from the credit radar can be done, but it is not easy and ends up costing you more money than it saves. Think about it. You can’t even win the lottery without creditors showing up and demanding a piece of the action.

The seven-year rule is essentially a statute of limitations on an outstanding debt. After seven years have elapsed, the debt should theoretically disappear. However, you should know which debts fall under this rule and which ones do not. Debts that should disappear after seven years include tax liens you have paid, accounts assigned to a collection agency or written off as a bad debt, and any delinquencies or debts that are older than seven years. Some information, such as bankruptcy, remains on your credit report for 10 years. A separate rule applies to judgments filed against you as the result of lawsuits; that information remains for either seven and a half years or until the legal statute of limitations on the judgment has passed, whichever is longer.

The seven-year mark begins from the first date the status is changed to a collection account. However, some people believe a debt can be re-aged, meaning the seven-year clock begins to tick all over again if the account is assigned to an additional collection agency. A debt collector cannot legally re-age a debt; to do so would violate two federal laws, the Fair Debt Collections Practices Act and the Fair Credit Reporting Act. If you discover that a debt has been re-aged, you have to immediately dispute it and cite these two laws that the practice violates.

If you are inclined to play cat-and-mouse with a collection agency, keep in mind that once the debt is finally written off, it may be reported to the IRS and may become taxable income to you. Even if you can prevent creditors and collection agencies from finding you, the IRS is not as easy to deceive. It will find you, and it will collect the taxes you owe.

If you are not working with the original creditor, but with a collection agency, you can apply the same three questions:

Here is a sad but true story about how the right steps can still lead to the wrong outcome:

Steve and Gail called me to refinance their home loan. Their previous lender had stuck them in an 8.5 percent subprime loan with a two-year adjustment due, and they wanted to lower their rate and replace it with a fixed rate.

Because their credit score had fallen due to medical collections, they could not qualify for the refinance. Here’s what had happened: Steve changed jobs and went to work for a new company. But his new boss missed a flight, which delayed his hire date by one week; naturally, this also delayed his medical coverage by one week. During the brief period when they did not have any medical insurance, Steve suffered a heart attack. The bills were enormous, as you would expect.

The bills went into past due status, so Steve and Gail had to scramble to pay them. They refinanced with a cash-out for part of it and emptied out their savings for the rest. They finally did pay off the bills, but had not negotiated in advance to get the past due status removed from their credit report. As a result, even though they were paid in full, the collections stayed on their credit report for seven years.

In this case, Steve and Gail—responsible, honest people whose credit scores and payment histories had been excellent before this incident—could not get a lower rate and had to live with the stigma of “past due” medical bills for the next seven years. They did the right thing but did not negotiate in advance to get the items removed. The right thing led to a very poor outcome.

I had another couple call me to obtain a home loan. This couple had recently sold their home and forgot to notify one of their medical providers with the updated mailing address—an easy mistake to make in the chaos of the move. A $22 collection appeared, making it impossible for them to qualify for a new mortgage loan. Even though they acknowledged the error and promptly paid the outstanding balance, a negative delinquency remained for seven years and dropped their scores.

Here are three things they could have done to save themselves a lot of headache:

Two kinds of companies are quite visible in the whole “creditfixing” industry. First is the debt settlement company. These organizations offer to negotiate your debt for you, often settling outstanding items for less than the amount owed. They advertise heavily, at times making promises they cannot always keep. A debt settlement company might be able to reduce your debts in some cases, but settled debts are still likely to stay on your credit report for seven years.

Pouring funds into these types of companies is likely to be a poor decision. Let’s crunch some numbers. A customer contacts a debt settlement company to help with $30,000 in credit card debt. The company may get the creditors to settle for less, or they put the account in dispute. However, the agency’s fee is 16 percent of the amount settled, and the customer gets a federal 1099 form at the end of the year for the difference—yes, the unpaid portion is taxable. So if the $30,000 debt is settled for $20,000, that leaves $10,000 of taxable income, or $2,800 in taxes due (if you’re in a 28 percent tax bracket). Since the debt settlement agency also charged $3,200 (16 percent of the amount settled), the real net outcome of this was a saving of only:

So you end up paying $20,000 to settle the debt and another $6,000 in taxes and fees. Debt settlement under these conditions is hardly a bargain There’s a reason why these companies have been under fire and heavily scrutinized in recent years—they should be. Many of these companies take advantage of people at their most financially vulnerable times and disguise themselves as a solution. The second type of organization is referred to as credit repair. These companies charge a monthly fee or flat fee to dispute items on your credit report. Typically, a company like this runs through your credit report putting items in dispute so that when your credit is pulled, the derogatory items are not included in the scoring. This does raise your credit score, but only temporarily. Instead, consider using your money not on the costly fees of a credit repair company, but to pay down these debts and work towards a permanent solution. Lenders have caught onto the credit repair companies’ tactics, and may no longer approve loan applicants with multiple disputed items on their credit report. This means that strategies centered on disputing items to temporarily raise your score in hopes to get a loan approved no longer work.

According to the attorney general of Texas, Greg Abbott, anything a credit repair agency can do, you can do yourself.³

You can dispute an item on your credit report without the help of an outside company. If you feel an item legitimately needs to be disputed, write a letter providing an explanation as to why you feel it needs to be removed. Be prepared to provide backup documentation if necessary. A sample letter follows (be sure to send the letter to all agencies reporting information in error):

As shocking as it might seem, I know for a fact that credit repair agencies are only successful about 10 percent of the time. I learned this from questioning my seminar attendees. The Bureau of Labor Statistics (www.bls.gov) estimates that from 2009 through 2016, the credit repair and debt collection industry is going to grow as astounding as 23 percent, much faster than virtually any other industry. Most of that increase will come from debt collection services provided to medical providers and government agencies. An independent study concluded that debt collection is a thriving business as well. In 2005 alone, U.S. businesses sent a whopping $141 billion in delinquent consumer debt to collections; collection agencies collected $51 billion in past due debt, keeping approximately one-fourth of the total as profit.

Remember these action points:

Here is how this came about: In 2008, an elderly couple showed up in my office in search of a reasonable mortgage. I discovered at once that they could not qualify for the best rates due to a small medical collection item on their credit report. It struck me as wrong that an isolated incident like this could drag down someone’s credit score, and I was curious to find out how many people were affected in the same way. What I found out was mind-blowing.

I was already aware that an outstanding medical collection remains on your credit report for seven years like other debts, even if you repay the debt. This is not fair, especially if your credit history has otherwise been pristine. In addition, medical billing is an error-prone system run by third party billing agents. Americans don’t ask to have heart attacks or accidents, so I asked the question—“Why is medical collection debt treated the same as other types of debt?” What I realized was that changing the law could boost the U.S. economy not by millions, but by billions—due to improved credit scoring rules for medical delinquencies. So I contacted U.S. House Representative Mary Jo Kilroy of Ohio’s 15th Congressional District and began the long (and expensive) process of crafting a new piece of federal legislation. The result was HR 3421, the Medical Debt Relief Act of 2009. This bill amends the Fair Credit Reporting Act and was introduced in the U.S. House of Representatives on July 30, 2009. Under existing rules, even a medical debt of only a few dollars can drag down the scoring enough to disqualify home, auto, and other loan applicants or result in higher interest rates. Under the new bill, credit bureaus will be required to remove medical debts from credit reports within 30 days after debt repayment.

The idea gained steam as it moved through Congressional review. In addition to its original sponsor Representative Kilroy, its co-sponsors include the Chair of the House Committee on Financial Services Subcommittee on Financial Institutions and Consumer Credit, Representative Luis Gutierrez of the Illinois 4th Congressional District, as well as dozens of additional co-sponsor representatives.

The bill is a win-win-win. First, non-credit related debts will not impact credit scores, enabling consumers to get interest rates gauged by their real credit histories. Second, medical providers benefit because patients have an incentive to repay the debt improving their percentage of successful collections. And third, the government and the country benefits as the economy is stimulated by more purchasing power and the resulting tax revenues from hospital/physician income.

Does this new legislation affect you? It will, especially in light of the fact that millions of Americans are adversely affected under the past rules. A total of 72 million Americans suffer from this, and medical debt is the number one cause of bankruptcy.⁴

There is much more to the collections business than most Americans know, and knowledge is power. Collection agencies are not your friends; they have one single goal—to collect your money. So your ability to negotiate is key. I even recommend practicing with a friend or family member to role-play the scenario. I have found that being nice makes it easier to deal with a collector rather than being mean or abrupt. The more you understand how it all works, the better equipped you are to protect yourself. Expanding on this point, the next chapter explains how the U.S. credit system works.