Understanding Credit Lifecycle: What Happens To All That Debt?

Key Takeaways
  • Lenders offer credit according to your ability to repay the debt.
  • Using collateral to secure a loan will lower the rate and provide better terms. It also gives lenders more recourse should you be unable to make payments.
  • Credit cards charge higher rates of interest because the creditor accepts more risk.
  • A creditor can sell your debt, creating a market for debt buyers.
  • The lower the risk of default the more buyers will pay for the debt.
  • The account payment history defines the quality of the account. The more delinquent an account becomes the less it is worth.

Part 1: Stages of The Credit Lifecycle and How the Value of Debt Changes Over Time

In an effort to take some of the mystery out of credit, credit collections, and loan defaults, we have put together a five-part series on the credit lifecycle. Today we start with the value of credit card debt to creditors. 

The Creditor Perspective

Applying for a loan involves gathering relevant information from your financial past for underwriters to review, before approving or declining your application. Lenders evaluate credit risk, based on the borrower’s ability to repay the debt. The job of the underwriting department is to weigh the risk of default and then set the loan terms accordingly. Most credit card applications have an automated underwriting process, which can provide an instant decision on an application.  

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When you use collateral, such as a home or car, you typically get better terms because the lender can take the asset in the event you default on the loan. Credit cards and other unsecured debts face higher interest rates and fees because the creditor has little recourse if you default on the loan

The Debt Buying Industry

Creditors service loans and lines of credit, which are considered an asset to the company. They have value based on the company’s ability to collect the balances owed. Like any asset, a company can sell the loan or line of credit to another company based on the market value of the debt

It is common for creditors to package debt notes and sell them to debt buyers, who can then collect the debt under the original terms of the loan or line of credit. Typically, credit card issuers may sell all or part of their portfolios to third-party debt buyers after the accounts have charged-off and are deemed uncollectible, although, in some cases, current, active paying account portfolios may also be sold to an acquiring company or other issuers or servicer.

Value of Current Payor Debts

Accounts that remain in a current payment status have the highest value. As long as the accounts remain current, the value of the debt remains the highest relative to the balance owed. 

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Impact of Late Payments on the Value of Debt

Creditors review payments over 30-day segments. The accounts are considered delinquent and remain in a “pre-charge off” status when you fail to make a payment for 30 to 179 days. For credit card accounts, banks and other card issuers are required to “Charge-off” an account after 180 days have passed without payment.  At this point, the account is deemed to be uncollectable and must be recognized as a loss for accounting purposes.  A pre-charge-off account holds more value than a charged-off account.  

Other Factors Impacting the Debts Value

In general, the value of a credit card account plummets the minute the first credit card payment is missed and continues to decline in value as the account goes further into delinquency.  As the account reaches charge-off at 180 days and beyond, the value of the account may fall to pennies on the dollar, based on a number of given factors including the amount of the debt, the residence of the debtor, the statute of limitations to litigate for recovery, the ability to garnish wages of the debtor and the perceived ability to collect the outstanding debt. 

Final Thoughts

When faced with delinquency or possibly a charge-off on an account, the creditor must weigh the cost of collecting the debt with the likelihood of recovering the money. In most cases, creditors will negotiate a lower payoff on unsecured debt, accepting less than the full amount owed and extending payment terms in order to recover some of their losses.

  • How do lenders make loan approval decisions?

     Lenders seek to limit the risk of loan default. To accomplish this, underwriters evaluate a few key factors depending on the loan type. Unsecured debt, such as a credit card, relies heavily on your credit score, with underwriters evaluating your income in relation to current debt levels (as viewed on your credit file), and your payment history. Secured loans also review your assets and the value of the asset used to secure the debt.

  • What is the difference between secured and unsecured debt?

    A secured loan is attached to property the lender can take if you get behind on your payments. Because a secured loan lowers the lender’s risk, you can get better rates and terms. Unsecured debt is riskier because of the lack of collateral and therefore lenders charge more in the form of higher interest rates. Creditors also have limited means to collect on the late debt.  

  • What is a debt buyer?

     A company that buys debt is a type of debt collector. The original lender can package similar debts and sell the accounts to a debt buyer. The sale of your account does not change the loan terms, but does require you to make payments to the new owner. 

  • Should I repay my charged-off debt?

     An account charge-off does not affect your legal obligation to pay the debt. The account owner can continue debt collection efforts including the right to take legal action against you if you refuse to pay the debt. Once an account reaches charge-off, lenders are more willing to negotiate the payoff for a lesser amount.