Why Do Collection Agencies Buy Debt?
Understand why collection agencies purchase old debts, how this financial practice works, and what it means for consumers.
Debt buying is a widespread practice where specialized agencies purchase outstanding consumer debts from original creditors. This process involves the transfer of ownership of delinquent accounts from banks, credit card companies, and other lenders to third-party entities. These debt buyers then assume the responsibility and rights to collect the owed amounts from consumers. This business is central to how non-performing assets are managed in the financial ecosystem.
Understanding the Debt Buying Business
Original creditors often sell delinquent accounts to clear their balance sheets. This helps financial institutions minimize losses on debts unlikely to be repaid through internal collection efforts. By selling these accounts, creditors reduce the administrative burden of managing long-overdue debts and reallocate resources to core business operations. They also mitigate risk associated with defaulted loans, receiving an immediate, albeit reduced, payment.
Debt buyers acquire these debts at a steep discount. They then attempt to collect a higher amount from debtors, forming their profit model. For example, a debt buyer might purchase a $5,000 delinquent account for $300, aiming to recover as much of the original amount as possible. This business thrives on economies of scale, as specialized agencies can collect more efficiently than original creditors due to their dedicated infrastructure and expertise. Even collecting a fraction of the original debt can yield a substantial return on investment.
Categories of Debt Purchased
Collection agencies purchase a variety of consumer debts that have become delinquent or “charged-off.” Common categories include credit card debt, medical debt, auto loan deficiencies, and other consumer loans. These debts are usually acquired after the original creditor has made several attempts to collect and determined recovery is unlikely through standard processes.
A “charged-off” debt is a declaration by the original creditor that debt is unlikely to be collected and written off as a loss on their financial statements. This typically occurs after 120 to 180 days past due, depending on the account type. Despite being written off for accounting purposes, the debt remains legally valid, and the debtor is still obligated to repay it. Debt buyers focus on these charged-off accounts, as they offer low-cost acquisition opportunities. The attractiveness of a debt portfolio depends on factors such as the debt’s age, documentation completeness, and previous collection attempts.
The Debt Acquisition Process
The acquisition of debt by collection agencies involves the sale of debt portfolios rather than individual accounts. Original creditors package large bundles of delinquent or charged-off debts, which can total millions in face value. These portfolios are then offered to debt buyers, often through specialized brokers or online marketplaces.
Debt buyers conduct due diligence on these portfolios, analyzing the age of accounts, debt type, original creditor’s past collection efforts, and debtor demographics. This analytical process helps them assess potential collectibility and determine a competitive bid price. After a bidding process, the sale is finalized, and ownership of the debt, along with documentation, transfers to the debt buyer. This grants the debt buyer the legal right to pursue collection.
What Debt Being Sold Means for Debtors
When a debt is sold to a collection agency, the new agency will directly contact the debtor for payment. Communications regarding the debt will now come from the debt buyer or an agency working on their behalf, often leading to new contact information and different collection tactics. Debtors might initially receive notification of the debt transfer directly from the original creditor or, more commonly, from the new collection agency.
The sale of a debt can affect a debtor’s credit report. The original debt may be marked as “sold” or “transferred,” and a new collection account will typically appear, often listed as a “charge-off.” This negative entry can cause an immediate drop in credit scores, potentially by 50 to 100 points or more, and generally remains on the credit report for up to seven years from the date of the original delinquency. A debt can also be sold multiple times, with each new agency potentially creating new entries on the credit report.
Debtors have rights when dealing with debt buyers under federal regulations, primarily the Fair Debt Collection Practices Act (FDCPA). Within five days of initial communication, the debt collector must send a written debt validation letter. This letter must include details such as the amount owed, the name of the current creditor, and a statement of the debtor’s right to dispute the debt within 30 days. If a debtor disputes the debt in writing within this 30-day period, the collector must cease collection activities until they provide verification. The FDCPA also protects debtors from abusive, unfair, or deceptive practices, including harassment, false statements, or contacting debtors at inconvenient times.