Back in 2016, John Oliver made national headlines when he bought and forgave millions of dollars in medical debt from hospitals in Texas. Not only did he highlight a huge problem that many Americans are facing, but he also shone the spotlight on the debt buying industry. Many people remain unaware that it has become a profitable industry. Although Oliver called it a “grimy business,” that isn’t always the case. Others are seeking to buy someone else’s debt to keep them from falling on hard times. So, if you have wondered how debt buying works or want to help a loved one, here’s what you need to know.
Why Do People Buy Someone Else’s Debt?
There are many reasons why people would want to buy someone else’s debt. Sometimes people want to help a loved one out of a difficult financial situation. Perhaps a friend or family member has lost their source of income, is dealing with illness, or has overwhelming medical expenses not covered by insurance. Or, maybe they simply took on too many financial responsibilities and can’t keep up with the payments. Taking over their debt could help someone avoid collections and prevent them from ruining their credit over a mistake.
Others buy debt for less altruistic reasons. Debt buyers, such as private collections agencies, can make huge profits from buying debt. They pay pennies on the dollar when they purchase third-party debts from the original lender. Therefore, anything they collect over the sale price equates to immediate returns on their investment.
The industry has attracted many new business ventures since it is under-regulated and requires little paperwork. In fact, you can legally buy debts in more than half of US states. And, 17 states don’t even require a license to collect debts. With a lack of rules and regulations though, you can see how it could lead to unethical practices.
How to Buy Someone Else’s Debt to Help
Unfortunately, it’s difficult to buy someone’s debt outright. However, there are ways to pay off what they owe or assume responsibility for their debt. Depending on the kind of debt and repayment terms, here’s how you can “buy” someone else’s debt.
Cosign a New Loan
If you are willing to assume the responsibility, you can cosign a new loan to pay off the old one. You would need to go through the process of applying for the new loan, which includes a credit check. Once approved, you would need to agree to the new terms, and then just sign on the dotted line to take over.
Transfer the Debt to Your Credit Card
If you have a good interest rate on your credit card, you could consider transferring their debt to your account. If you can provide a lower interest rate on the balance, it could save them money and reduce monthly payments. You could also look at opening a new credit card that offers 0% interest rates and separate the debt from your other expenses.
Add Your Name as Guarantor
If cosigning for a new loan isn’t an option, you can also ask to add your name as a guarantor on the loan. However, you would need to contact the creditor or lender directly to put your name on the account. Then, you would be able to pay off their debt.
Settle the Debt
If the debt has already been sent to a collection agency, the damage to their credit is done. But, you may be able to make arrangements with the lender and get them out of collections. They often allow you to create a repayment plan or settle for a lump-sum payment. Since they will still make a profit, collection agencies may be willing to settle for only 20-30% of what was originally owed.
Becoming a Debt Buyer
If you’re looking to buy someone else’s debt as an investment opportunity, you have to think bigger. You can’t buy individual debts. Instead, debt buyers purchase large portfolios or “strips” containing multiple delinquent debts. The strips usually have a random assortment, but often include debt from credit card issuers selling to recoup money and cut their losses. Buying this kind of debt is a big risk since there is no guarantee that you will collect enough to cover the initial cost.
However, since most debt is sold for $0.04 to $0.14 on the dollar, many debt buyers assume they will still turn a profit. Some also break it into smaller strips and sell them to investors with less capital. While many of these debts will never get repaid, collected debts beyond the purchase price can yield a good return on the investment.
While some may see it as “grimy,” it can be beneficial to the debtors as well. Since debt buyers have less money at stake, they are often more flexible and willing to negotiate payment. They will try to establish a repayment plan or accept a settlement to get as much of the loan back as possible.
Things to Consider
Even for those with the best of intentions, there are always risks to consider. First and foremost, money can complicate relationships. If you have a personal relationship with the individual holding the debt, it could create tension and strain your relationship. Should they fail to honor any agreements you made, you will still be left with their debt. Furthermore, there is no way to hold them accountable if you legally assumed responsibility either.
As an investor, there are no guarantees that the strips you buy will be profitable. It’s a huge gamble since you could buy a portfolio that contains nothing but junk. However, that’s all part of the game.
In either case, buying debt should not be an impulsive decision. You need to carefully consider the risks you are taking on, weigh your options carefully, and discuss them with your financial advisor. You should think about all possible outcomes before you find yourself in a financial situation you can’t get out of.
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Jenny Smedra is an avid world traveler, ESL teacher, former archaeologist, and freelance writer. Choosing a life abroad had strengthened her commitment to finding ways to bring people together across language and cultural barriers. While most of her time is dedicated to either working with children, she also enjoys good friends, good food, and new adventures.