What Is Debt Buying and How Does It Work?
Learn the fundamentals of debt buying: how this financial transaction works, its implications, and governing rules.
Debt buying involves the acquisition of delinquent or charged-off consumer accounts by specialized companies from original creditors. These transactions typically occur when a lender has determined that a debt is unlikely to be collected through their internal efforts. This practice allows creditors to recover some value from accounts they might otherwise consider a complete loss. The debt buyer then assumes the right and responsibility to collect on the purchased debt.
The Debt Buying Process
Original creditors, such as banks or credit card companies, sell accounts that are significantly delinquent or “charged off.” A charge-off occurs when a creditor removes an uncollectible debt from its active balance sheets, usually after about six months of non-payment, for accounting or tax purposes. This action does not erase the consumer’s obligation but signifies the creditor’s decision to no longer actively pursue the debt internally. Selling these accounts provides immediate cash flow for the original creditor, allowing them to recoup a portion of their losses.
Debt buyers acquire these accounts, often bundled together in large portfolios, for a fraction of their original face value. The purchase price can vary significantly, ranging from 1 cent to 20 cents on the dollar, with older debts typically selling for less due to lower collectability. This business model allows debt buyers to generate a profit even if they collect only a small percentage of the total amount owed across the portfolio.
Once the debt buyer acquires the portfolio, ownership of the debts is transferred to them. They then become the new creditor and are entitled to collect the full amount owed, including any applicable interest and fees permitted by the original agreement. Debt buyers may attempt to collect the debt themselves or outsource collection efforts to third-party collection agencies or law firms.
Key Entities and Acquired Debts
The debt buying ecosystem involves three parties: the original creditor, the debt buyer, and the consumer. The original creditor is the entity that initially extended credit or provided services, such as a bank, credit card issuer, hospital, or utility company. When a consumer fails to make payments, this creditor may eventually sell the debt.
Debt buyers range from small private businesses to large corporations. Some actively engage in collection themselves, while others, known as passive debt buyers, may resell portfolios or hire other collection agencies. The consumer is the individual who originally incurred the debt and whose financial obligation is now owned by the debt buyer.
Credit card debt represents a significant portion of purchased debt portfolios. Frequently acquired debts include:
- Medical bills
- Auto loan deficiencies
- Utility bills
- Personal loans
- Student loans
- Mortgage deficiencies
Consumer Considerations
When a debt is sold to a debt buyer, consumers may experience changes in how collection attempts are made. The new debt owner will initiate contact to seek repayment. While your original creditor may not have been subject to certain regulations when collecting their own debt, a debt buyer generally is, particularly if debt collection is their primary business.
A debt buyer is required to send a debt validation letter within five days of their initial contact. This letter should contain specific details, including the amount of the debt, the name of the original creditor, and a statement of your right to dispute the debt within 30 days. Consumers should pay close attention to this validation notice and respond within the specified timeframe if they believe the debt is inaccurate or not theirs. Disputing the debt within this period requires the debt collector to verify the debt before continuing collection efforts.
The sale of debt can impact a consumer’s credit report. When a debt is charged off and then sold, both the charge-off status and the subsequent collection account can appear as negative marks on the credit report. These negative entries remain on a credit report for up to seven years from the date of the first missed payment that led to the delinquency. If a debt buyer attempts to alter the date of the original debt to make it appear more recent, this practice, known as re-aging, is illegal under the Fair Credit Reporting Act. Consumers have the right to dispute inaccurate information with credit reporting agencies.
Governing Regulations
The debt buying and collection industry operates under a framework of federal laws designed to protect consumers. The Fair Debt Collection Practices Act (FDCPA) governs the conduct of third-party debt collectors, including debt buyers whose principal business purpose is debt collection. This act prohibits abusive, unfair, or deceptive practices. The FDCPA also establishes specific consumer rights, such as the right to receive a debt validation notice and to dispute the debt.
The Fair Credit Reporting Act (FCRA) focuses on the accuracy, fairness, and privacy of consumer credit information maintained by credit reporting agencies. It limits how long negative information can remain on a credit report, seven years for most delinquent accounts. The FCRA also provides consumers with the right to dispute inaccurate information on their credit reports and requires debt buyers to notify consumers if they report negative information to a credit reporting agency.
Regulatory bodies such as the Federal Trade Commission (FTC) and the Consumer Financial Protection Bureau (CFPB) oversee the debt buying and collection industry. These agencies enforce the FDCPA and FCRA, investigate complaints, and issue guidance to ensure compliance with consumer protection laws.