How Zombie Debt Works

Growth in the Collection of Zombie Debt

Despite a full-time position as a public relations specialist, Beth O'Connell faced a $20,000 credit card and student loan debt in 2004 exacerbated by zombie debt.
Despite a full-time position as a public relations specialist, Beth O'Connell faced a $20,000 credit card and student loan debt in 2004 exacerbated by zombie debt.
Photo by Melanie Stetson Freeman/The Christian Science Monitor via Getty Images

To understand why zombie debt is big business, you need to know a bit about debts, debt collection and consumer credit.

Let's say that in 1994 Jane, fresh out of college and awash in debt, defaulted on a credit card. In 1996, she entered bankruptcy. Since then, she's painstakingly rebuilt her credit, paying her bills on time and checking her credit report at least once a year. Because more than seven years have elapsed, the old default and the bankruptcy proceedings no longer even appear on her credit reports.

But what happened to that default? The credit card company wrote it off as bad debt -- that is, the company took the debt as a loss. You'd think it might stop there, but you'd be wrong.

When a company writes off a debt, it often sells the debt to a collector. Depending on the age of the debt, the collector might pay as much as 12 cents for every dollar owed, or as little as a fraction of a penny [source: Weston]. What's the point of this transaction? It enables the company selling the debt not to take a total loss. If Jane defaulted on a $100 debt, selling the debt at 12 cents per dollar lets the company turn it into an $88 loss, thereby recovering $12.

But what does the collector have to gain? The collector is betting that it can succeed where the old company failed. Paradoxically, they're more likely to go after Jane because she has rebuilt her credit. They think she's more likely to pay, because she doesn't want to ruin her credit again. And often, they're correct. These companies turn giant profits because their practices often succeed in wringing dollars out of individual consumers.

If the collector convinces Jane to pay that $100, the collector has just made $88. In the first few years of this decade, these profits exploded -- to the tune of $110 billion in 2006 alone [source: Weston].

Zombie debt has become profitable in part because of two trends that took off in the 1990s: consumer credit and identity theft. Credit companies realized they could make more money in interest payments by extending higher-interest lines of credit to consumers who carried debt from month to month -- the people most likely to default. The buying and selling of debts became big business. And identity theft created giant backlogs of bad debts for collectors to pursue.

Here's a more serious question: Is zombie debt collection even legal? Strictly speaking, yes -- if the collectors don't violate the Fair Debt Collection Practices Act.

Kent Anderson, an attorney specializing in consumer debt, notes that collectors "often take the position that it is lawful to remind the debtor it remains a moral responsibility to pay the debt" [source: Anderson]. Getting a lecture on morals from a collection agency may seem a bit rich, but don't be too quick to laugh it off. In 2005, the debt collection industry was the single biggest source of consumer complaints to the Federal Trade Commission.

What would you do if a debt collector resurrected some old amounts? Find out how to protect yourself on the next page.