Introduction to How Zombie Debt Works

Nine years ago, someone stole your wallet right out of your coat pocket. You never even saw the guy. He used your credit cards to buy $1,300 worth of shoes. Of course you reported the theft as soon as you found out, and the credit card company declared you not responsible for the debt. Lesson learned, end of story. Right?

Today, you have a nice sturdy paycheck and a sound credit rating. In fact, you’ve got your eye on a gorgeous loft-condo. Suddenly the phone rings …

That old theft has come back to haunt you. The collection agency says that, with interest, the debt on that $1,300 now comes to more than $10,000. The agency has no record of your fraud report and considers you responsible for the debt. The agent informs you that if you don’t pay up — and soon — you could risk legal action. And the debt could jeopardize your loan application for that condo.

Surprise: You’ve just come face to face with zombie debt.

The Debt Lives!
Unfortunately, the zombie metaphor is incredibly apt. On the credit market, debts are sold and resold from agency to agency, so something you may have settled — even more than once — can spring back to life, with no record of past payments. Collectors grab for whatever they can ­get. And the debts are hard to kill.

Zombie debt has become profitable in part because of consumer credit and identity theft.
Frederic J. Brown/AFP/Getty Images
Zombie debt has become profitable in part because of two trends that took off in the 1990s: the proliferation of consumer credit and identity theft.

Zom­bie debt gets its name because the debts in question are supposed to be dead and buried since:

  • They’ve been settled in bankruptcy proceedings.
  • They’re the result of mistaken identity or identity theft, so they were never your responsibility to begin with.
  • Their statute of limitations has expired.

These debts are reanimated by collection agencies hoping to make some extra profits.

You know the guy in the B movie who seals his own doom by panicking and getting himself cornered by the relentless zombie army? Zombie debt collectors expect you to be that guy. They make their profits from consumers who don’t know their rights, don’t know how to protect themselves, and panic.

To learn how not to be that guy, and how zombie debt has become such a hot topic, read on.

­

Growth in the Collection of Zombie Debt

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

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
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.

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.

Who Profits from Zombie Debt?

The collection agencies seem to be doing pretty well:

  • Asset Acceptance Capita’s revenues quadrupled between 2001 and 2005.
  • Encore Capital Group’s revenues went from $47.8 million (2001) to $221.8 million (2005).
  • NCO Financial Systems had revenues of $936 million in the first three quarters of 2007, despite federal actions against the company [source: Dalton].

The credit card companies fare better when they sell old debts, because the immediate influx of cash increases their quarterly earnings [source: Dalton]. And people who have invested in these companies do well when the companies post higher earnings, because the stock prices usually go up.

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.

How to Deal With Zombie Debt Collectors

Some of the worst problems with zombie debt arise when the debt appears just as a consumer is making a major purchase, such as a house or a car. Confused about their rights or simply anxious about obtaining their new loan, many consumers pay old debts to settle the issue quickly. And some people fall victim to a one-two punch of identity theft and their own poor record keeping: They wind up paying debts that weren’t even theirs in the first place.

Danielle Rhoades
Getty Images
Living economically after transferring her $10,000 debt to a zero-percent interest credit card, Danielle Rhoades was able to pay off her debt in a year.

So what do you do?

  • Know your rights. Debt collectors are not allowed to threaten you, harass you, or threaten to sue you.
  • Don’t acknowledge that the debt is yours, or even that you recognize it.
  • Get things in writing. Ask for information about where the debt originated — when, from whom, for how much. Check that information against your credit report and your other records.
  • If you don’t owe the debt, send the collection agency a written demand to stop contacting you. Send it certified mail, with a return receipt, and send it within 30 days.
  • Get a discharge order. Have you filed for bankruptcy since then? If so, your discharge order should protect you from attempts to collect this debt.
  • Determine the age of the debt. After six or seven years, you have certain protections under federal law.
  • Know your states statute of limitations. In some states, you may actually injure your credit rating further by making a payment on the debt. You might reopen the debt’s statute of limitations. And the collector, having succeeded in obtaining some money, might try to pursue the rest. Though no one condones defaulting on your obligations, some consumer advocates say that in this situation, your best option is to ignore the zombie debt collector. Even if you don’t dispute the debt, no court may consider your silence “an admission of liability” [source: Federal Trade Commission].
  • Be smart about your finances. Don’t wait for a problem to arise. Pay your bills on time, and check your credit score routinely. If you’re planning a major purchase, be familiar with your credit report well in advance.

Who’s on Your Side?

You have resources, including:

­If we’ve learned anything from the movies, it’s this: There are ways to keep zombies from eating your brain. Bar the doors, choose and understand your weapons, figure out your escape route, and you may soon find yourself victoriously standing down the debt apocalypse.