Sunday, March 27, 2011

Buying Bad Debt: Important Strategies Pertaining To Speculators

By Kevin A. Smythe

When a brokerage firm or debt collection agency decides to acquire a portfolio of bad debt from a bank or other credit agency, it must determine the most lucrative investment options available. In many cases, buying bad debt can be more profitable if the debt is older because a greater percentage can be collected. Fresh debt is harder to collect because of the circumstances that led to a debtor not fulfilling the obligation to pay in the first place.

A charge off is typically caused by a circumstance that reduces or removes the debtor's ability to pay even a portion of the debt owed the creditor. Lack of employment, sickness, and other difficulties lead to the issuing creditor's inability to recover even a fraction of the bad debt, even though many banks are willing to seek as little as $0.15 on the dollar of the debt owed.

With the banks pursuing such a small percentage of the debt and having little success, how can an outside firm buying bad debt profit? Simply put, the odds are against them.

When the charge offs are fresh, there is a greater chance that the debtor will file for bankruptcy, therefore not paying any of the debt owed. However, if the debt is over a year old, buying bad debt can lead to greater return on investment for the debt collection agency.

At this time, banks are likely to stop the pursuit of bad debt, having used enough resources attempting to collect on the money owed. Rather than use any more time and money, they will often be pleased to sell the portfolios for a minimal return, simply to rid their books of bad debt.

At this point, the brokerage firm buying bad debt can more easily pursue debtors for a higher sum, having given the debtor time to recover from whatever occurrence or issue caused them to default on their payments in the first place. After a year to 18 months, the debtor most likely has ironed out a number of issues, including finding employment or recovering from illness, and will be able to pay a greater portion of the debt owed.

In contrast, fresh charge offs are more difficult to turn into a profit. Banks are looking for a greater percentage in order to sell the bad debt portfolios, and debtors have fewer resources with which to repay their debt. Also, with the issuing creditor and possibly other agencies having been in pursuit of the debt for a greater amount of time makes the debtor more likely to want to end collection calls.

Though logic may state that a fresher debt is easier to pursue, the opposite is true. Buying older debt leads to greater profit margins for brokerage investors. The original creditor is more likely able to successfully collect on fresh charge offs, leaving older debt portfolios as a source of income for debt collectors.

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