At first glance buying debt does not seem to make any sense. Why would anyone want to purchase a portfolio that has been deemed noncollectable by the original creditors? The reason is, people and companies that purchase debt portfolios for sale make a substantial profit on their investment. The portfolio is purchased for a few pennies on the dollar, yet the second creditor will attempt to collect the entire amount. Even if the second creditor only collects one fourth of the portfolio, it will still make a huge profit.
A portfolio is a basket of unrelated debts that are packaged as one purchase for the buyer. Consumers may not intentionally abuse credit, but when they have to borrow from one source to pay another, it becomes the road to financial ruin. It can take years for bad financial habits to eliminate the capacity to borrow or get credit. When this happens, collection calls, bad credit scores and wage garnishments become a part of every day life for the consumer.
Some debtors wind up filing bankruptcy, but many are able to avoid bankruptcy. It is costly for creditors to collect on receivables that are not paid promptly. After a period of time, creditors will sell the unpaid receivables to a third party and write off the debt. The second creditor that buys the portfolio will only pay about four cents on the dollar, on average. Newer debt may be a few pennies more and older a few pennies less. As an example, the first creditor that owns twenty thousand dollars of debt will sell the entire portfolio to a second creditor for eight hundred dollars.
If the second creditor in this example is able to collect twenty five percent of the portfolio, it will collect three thousand five hundred dollars. In this example, their profit is two thousand nine hundred forty dollars. Even if creditor number two never collects one more penny on this portfolio, it has made a return on its original investment of roughly 5.25, which translates into five hundred twenty five percent ROI.
On a grander scale, sometimes the basket of debt is from a retailer like a credit card company. In this case, the portfolio will be much larger. In this example, the portfolio is valued at one hundred fifty thousand dollars. The second creditor buys the debt for four cents on the dollar, which is six thousand dollars.
In this numbers game, the second creditor is able to collect twenty five percent of the portfolio, fifty thousand dollars. Subtracting its investment of 8,000 dollars, creditor number two has a profit of 42,000 dollars. Again, 5.25 times the investment or an ROI of five hundred twenty five percent.
This explains why people and companies purchase debt. They make lot of money on a modest investment. Usually, creditor number two will sell the remainder of the portfolio to another creditor. This time around the cost will be close to two cents on the dollar. Still, even if it only collects on a small portion of the portfolio, the third creditor will make a substantial profit.
This is all good news for the creditors, but nothing in these scenarios benefits the consumer debtor. Credit can be a good thing when used wisely, but it can be very bad when abused. Consumers should be educated to use credit sparingly and live within their income.
A portfolio is a basket of unrelated debts that are packaged as one purchase for the buyer. Consumers may not intentionally abuse credit, but when they have to borrow from one source to pay another, it becomes the road to financial ruin. It can take years for bad financial habits to eliminate the capacity to borrow or get credit. When this happens, collection calls, bad credit scores and wage garnishments become a part of every day life for the consumer.
Some debtors wind up filing bankruptcy, but many are able to avoid bankruptcy. It is costly for creditors to collect on receivables that are not paid promptly. After a period of time, creditors will sell the unpaid receivables to a third party and write off the debt. The second creditor that buys the portfolio will only pay about four cents on the dollar, on average. Newer debt may be a few pennies more and older a few pennies less. As an example, the first creditor that owns twenty thousand dollars of debt will sell the entire portfolio to a second creditor for eight hundred dollars.
If the second creditor in this example is able to collect twenty five percent of the portfolio, it will collect three thousand five hundred dollars. In this example, their profit is two thousand nine hundred forty dollars. Even if creditor number two never collects one more penny on this portfolio, it has made a return on its original investment of roughly 5.25, which translates into five hundred twenty five percent ROI.
On a grander scale, sometimes the basket of debt is from a retailer like a credit card company. In this case, the portfolio will be much larger. In this example, the portfolio is valued at one hundred fifty thousand dollars. The second creditor buys the debt for four cents on the dollar, which is six thousand dollars.
In this numbers game, the second creditor is able to collect twenty five percent of the portfolio, fifty thousand dollars. Subtracting its investment of 8,000 dollars, creditor number two has a profit of 42,000 dollars. Again, 5.25 times the investment or an ROI of five hundred twenty five percent.
This explains why people and companies purchase debt. They make lot of money on a modest investment. Usually, creditor number two will sell the remainder of the portfolio to another creditor. This time around the cost will be close to two cents on the dollar. Still, even if it only collects on a small portion of the portfolio, the third creditor will make a substantial profit.
This is all good news for the creditors, but nothing in these scenarios benefits the consumer debtor. Credit can be a good thing when used wisely, but it can be very bad when abused. Consumers should be educated to use credit sparingly and live within their income.
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