The debt collection industry is like a dark, swirling vortex lurking at the edges of the consumer finance world, ready to suck in struggling borrowers who miss too many payments. While most of us don’t think much about debt collectors until we encounter them, they wield major power and influence in the world of consumer debt.

Hundreds of collection agencies across America specialize in relentlessly pursuing past-due debts on behalf of banks, credit card companies, hospitals, and other creditors. Some simply provide collection services, while many others buy up massive portfolios of severely delinquent debts for pennies on the dollar, and then aggressively collect from debtors to turn huge profits.

It’s a murky, cutthroat business fueled by consumer misfortunes and misery. In this article, we’ll shine a light on how debt buyers and collectors operate, the kinds of toxic debts they traffic in, and the controversial tactics they use to squeeze money from the financially distressed.

Understanding the machinery of the bad debt underworld can help arm consumers with knowledge to defend themselves from predatory collections. So let’s delve into the shadowy dealings of bad debt buyers and collectors profiting from the unpaid bills of the desperate and downtrodden.

What is Bad Debt?

First, what exactly constitutes “bad debt”? In the consumer finance world, bad debt refers to any accounts that are severely past due or in default. This means the borrower has missed multiple payments over an extended period of time, violating their credit agreement.

Once an account becomes delinquent, usually 90 days or more overdue, the original lender or creditor will often “charge it off” – which means removing it from their books as an asset and reclassifying it as a loss. They’ve given up hope of recovering what’s owed, at least directly from the borrower.

Charge offs allow creditors to take tax deductions for the losses. The overdue accounts also get reported to the major credit bureaus, trashing the debtor’s credit scores.

But legally, charging off debt does not erase the borrower’s obligation to pay. Creditors retain the right to hire collection agencies, re-sell the debt to a third party, or sue borrowers for what’s owed.

That’s where debt buyers and collectors come in. They sweep up massive portfolios of charged-off accounts for cheap, then deploy every legal and ethically-dubious tactic possible to wring out payments. Even if they only collect a fraction of the balances, the profits stack up fast when you pay 5 cents on the dollar for the debt.

In other words, bad debt collectors prey on the financial misery of the down and out for revenue and tax benefits. Now let’s examine how they get their hands on all that toxic debt.

How Do Collection Agencies Buy Bad Debt?

There are two main methods collection agencies use to acquire portfolios of delinquent debt from original creditors and debt owners: 

Debt Purchasing

The most common method is direct debt buying. Collectors purchase portfolios of charged-off accounts in bulk from credit issuers, banks, payday lenders, utilities, auto financing companies, and other credit providers. Most debts are sold through private bidding or auctions.

For example, a credit card issuer may charge off thousands of deeply delinquent accounts every month and bundle them into portfolios to sell. Large debt buyers will bid on these portfolios, often paying just pennies on the dollar – $20 for a $1,000 debt, for instance. The buyer then owns the right to try to collect the full balance.

Forward Flow Agreements

Some debt collectors utilize ongoing forward flow contracts with creditors. This provides them with a consistent volume of new delinquent debts at set prices. 

For instance, a collector may contract with a bank to purchase a specified volume of its defaulted credit card debts each month for the next year at a fixed rate of 20% of the balance. The bank generates steady revenue on bad debts, while the collector has a predictable inventory of new accounts to collect on.

What Kinds of Debts Do Collection Agencies Buy?

Collectors purchase many types of delinquent consumer debt accounts, including:

Credit Card Debt

Defaulted credit card balances make up around two-thirds of all debts sold to collection agencies. With Americans owing over $800 billion in credit card debt, there is no shortage of bad credit card debt available for sale. Issuers charge off billions annually.

Capital One, Citibank, and Discover are among the credit card companies known to sell debt to collectors. Credit card accounts are sold individually as well as bundled into regional or national portfolios.

Medical Debt 

With healthcare costs continuing to rise along with underinsurance, medical debt is a massive market, with nearly $140 billion in medical bills going unpaid annually. Hospitals, clinics, labs, and other providers sell off millions in past-due patient accounts.

Some medical debts are sold to collectors while still fresh, as early as 90 days past the billing date. The largest buyers of medical debt include accounts receivable management companies like MedCredit and Accretive.

Payday Loans

Payday lenders issuing high-interest, short term loans sell off a large volume of bad debts, as their customer base often struggles with repayment. Delinquent payday loan accounts are frequently sold to subsidiary collectors owned by the payday lenders themselves. Major payday lenders promoting these sorts of services include Advance America, Check N’ Go, and Ace Cash Express.

Auto Loans

Banks, auto financing companies, and auto dealerships sell off repossessed car loans as well as severely late auto loan payments to agencies who specialize in collecting on auto deficiencies. 

Some of the largest auto debt buyers are Santander Consumer, Credit Acceptance Corp, Westlake Financial, and Wilson Auto Group. Repossessions and deficiencies can be sold as individual accounts or bundled portfolios.

Mortgages

Most defaulted mortgages are handled by the original bank or lender and end in foreclosure rather than sale to a third party. But some past-due mortgages and home equity loans do get sold to debt buyers, usually as regional portfolios of similar debts rather than single accounts.

Distressed mortgages are often sold when the borrower has abandoned the home and there is little prospect of collecting. This usually occurs before the foreclosure process is initiated.

Why Do Original Lenders Sell Bad Debt?

Creditors sell off their toxic, severely delinquent accounts for a few key reasons:

– Remove bad debts from their books – Banks and lenders want to clean up their balance sheets by recording charged-off accounts as losses and getting them off the books. This improves financial statements and metrics.

– Recover something – The creditor recovers a portion of the bad debt by selling it, often around 10-30% of the balance. This brings in revenue on accounts they’ve written off.

– Save on costs – Collecting bad debts takes staff time and resources. Selling it saves them collection costs.

– Avoid borrower ill-will – By selling it rather than collecting in-house, creditors avoid directly alienating severely delinquent customers.

– Focus on earning assets – Creditors can focus on servicing performing loans and assets that generate income rather than chasing bad debt.

– Specialized collectors may have better luck – Collection agencies may have more capacity, flexibility, and aggressive tactics to extract payment.

– Tax benefits – Charge-offs and debt sales can offer tax deductions for lenders as losses.

Overall, selling severely delinquent receivables provides upside for the original creditor, while offloading the hassle of collecting toxic debt.

How Do Collection Agencies Profit From Buying Bad Debt?

If collection agencies are only paying pennies on the dollar to purchase debts, how do they earn a profit? Collectors rely on various methods:

Buying Debt at Deep Discounts

The greatest opportunity is simply the gap between the low purchase price and the potential to collect the full original balance from debtors. 

If a collector buys a portfolio of credit card debt with a total face value of $1 million for just 10 cents per dollar owed, or $100,000, they stand to make $900,000 if they can recover the full balances. Even marginal collections generate big returns. 

Using Aggressive Tactics to Collect

Collectors utilize all legal means possible to compel debtors to pay up. Calling frequently, making threats, pressuring family, filing lawsuits, garnishing wages, placing liens on property, and harassing the indebted are common tactics used to collect on purchased bad debts. For instance, a collector may extract $1,000 from a debtor on an account they paid $200 to acquire.

Some collectors break the law with illegal practices like excessive calling, abusive language, empty threats of jail time, collection on expired debt, inflated balances, and disclosure of debts to employers or family. Authorities often fail to crack down on rogue tactics.

Reselling Debt

If initial collection efforts on purchased debt fail, collectors may repackage and resell the accounts to another agency. The debt can be resold over and over. With each sale, the price drops further.

For example, Midland Credit buys debt from Citibank for 8 cents per dollar, tries to collect for a year or two, then bundles and sells what it couldn’t collect to another agency for 4-6 cents per dollar. This debt flipping generates revenue on accounts they couldn’t collect on.

Tax Benefits

Another avenue for profit is tax savings. Just like original creditors, collection agencies can claim charge-offs on uncollected debt they own as losses come tax time. These write-offs subtract from their taxable income.

Portfolio traders may also benefit from capital loss deductions when they sell debts. Say a collector sells a portfolio of debt originally bought for $200,000 to another agency for $100,000 after failing to collect. The $100,000 loss applied to their taxable profits saves them $35,000 in taxes owed if they are in the 35% tax bracket.

Are There Risks to Buying Bad Debt?

While purchasing severely delinquent accounts can be extremely lucrative, collectors do face some hazards:

Inaccurate or Unverifiable Debt

One major risk is that the debts lack enough information to verify accuracy and proper ownership. Accounts may have incorrect balances, wrong contact info, multiple borrowers mixed together, or lack documentation. Weak ownership makes legal collection difficult. Collectors may end up harassing the wrong people over invalid debts.

Purchasing medical debts is especially prone to incomplete or erroneous information that prevents effective collection. 

Lawsuits and Regulations

Harsh collection practices often lead to lawsuits over illegal tactics as well as penalties from state and federal regulators. Debt collectors ranked 1 on the FTC’s list of most complained about industries, with over 75,000 complaints against collectors in 2020. State attorney generals often file suits against collectors for abusive practices violating consumer protection laws.

Class action lawsuits can also be very costly. Portfolios found to contain a large percentage of inaccurate or unverified accounts legally deemed “defective” have led to major lawsuits against debt buyers.

Uncollectible Debt

No matter how aggressive the tactics, some bad debt is simply uncollectible due to the debtor’s financial situation. The debt may be expired past the statute of limitations and no longer legally enforceable. Or the borrower may be unemployed, disabled, or bankrupt with no ability to repay. That leaves collectors with substantial worthless debts still on their books.

Ethical Considerations Around Buying and Collecting Bad Debt

The business of buying and collecting bad debt raises many ethical concerns, including:

– Lack of transparency and weak regulation in debt sales markets. Debts are often sold with minimal information and oversight.

– Loose collections standards frequently bordering on illegal harassment of debtors. Regulatory penalties are mild compared to profits.

– Taking advantage of debtors who are financially vulnerable, including the poor, disabled, and elderly.

– Draining income from debtors struggling with basic expenses to benefit wealthy debt buyers.

– Resale of debt in an endless chain with accounts changing hands endlessly with no statute of limitations.

– Conflict of interest inherent when payday lenders sell their own defaulted loan debt to their sister collection companies. 

– Limited efforts to verify debt accuracy during sales and collections, pursuing borrowers for unverified or invalid debts.

– Driving debtors into severe hardship through aggressive collections, wage/asset seizures, and endless interest accumulation.

Many experts argue bad debt collectors prey on the financial misery of consumers for revenue and tax savings. The industry warrants much stricter regulations and oversight.

Conclusion

The purchasing and collecting of charged-off bad consumer debt has ballooned into a massive shadow industry propelled by banks, creditors, and specialized collection agencies. 

Toxic, severely delinquent debts are sold off cheaply in bulk in order to clean up lenders’ balance sheets. Collectors then utilize all legal and questionable means to try to extract payments, earning big profits on accounts bought for pennies on the dollar.

This system has raised many ethical and legal issues around the validity of debts and overly aggressive collection tactics that take advantage of consumers in financial distress. Additional oversight and reforms are likely needed to rein in the Wild West practices of bad debt collectors and traders.

Overall, the buying and reselling of bad consumer debt represents a murky but highly lucrative corner of the financial industry focused on profiteering from the misfortunes and mistakes of borrowers caught in the debt spiral. How and whether to reform this system represents an important challenge to protect consumers from predatory collections.