How can you make money by paying off $10 million dollars in debt? Ask Dave Ramsey

I received an email the other day and the subject line read: “A Story of Forgiveness Filled With Christmas Spirit” and above the fold in the email’s preview window was a nice graphic, which just below it said:

Forgiven: Ramsey Solutions Pays Off $10 Million of Debt for 8000 People.

On Dave’s blog it reads this way:

Naturally, I thought (as was certainly intended), “Wow, how incredibly generous — paying off $10,000,000 in debts. That is major league charitable giving”.

Further down in the blog is this question:

“Why the heck would anyone just scoop up $10 million worth of debt and pay it off just like that?”

I thought the same thing myself, and then it dawned on me…hmmm, maybe that’s not exactly what happened. Let’s unwrap this “Christmas present”.

First, let’s do a little bit of math.

If Ramsey solutions paid off $10,000,000 in debt to 8,000 people then the average debt paid for each of these 8,000 people was $1,250. Even if that’s a relatively small amount in the big picture of debt, you gotta say to yourself, “Even so, $10,000,000, that’s incredibly generous.”

But did Dave really pay off $10,000,000 of debt?

The answer is, on paper, yes. In reality, no. Far from it. In fact, rather than costing them $10 million dollars, Ramsey Solutions will probably make a lot of money off that deal.

You might say to yourself “How is that even possible?”

Well, in order to realize that the only people who may have benefited from this deal is Dave and his company, you have to understand how the debt business works.

Whenever you have debt, regardless of where that debt comes from, whether it’s medical bills, utility bills, car payments, mortgage payments, credit cards, etc., there are generally only two places that actually service that debt. Obviously, mortgage payments and car loans often originate at a bank, as is the case of most credit cards as well. Even credit cards offered by a store or gas station have an underlying bank that is the issuer. The other source might be a finance company. Personal loans, car loans and often medical bills are very often financed through a finance company.

With regard to your debt, these sources are called your ‘original creditor’ and they have extended some credit to you under certain terms and conditions which are basically a legal contract. If you fail to meet those terms and conditions, including failing to pay, the creditor then has the right to take action and attempt to collect the debt from you. If their attempts to collect the debt are unsuccessful, the original creditor will eventually declare your debt a ‘charge off’. That declaration is your creditor’s way of saying ‘We don’t think this person will work pay the debt’, and there are actually federal regulations for when creditors must do this.

For example, installment loans must be charged off after 120 days of delinquency. In other words, if you don’t pay your car loan for four months straight, the next month your creditor must declare your loan a charge off. Revolving credit lines AKA credit cards have a different timeline of 180 days of delinquency but the result is the same. After that 180 days your account must be declared as a charge off.

What happens next is where things start to get complicated. The original creditor has several options. They can continue to attempt to collect on the debt using their own in-house staff of collection agents or they might farm it out to a third party collection agency, or they can initiate a lawsuit in hopes of some settlement, or they can sell your debt to what is known as a ‘debt buyer’.

When Ramsey solutions acquired that $10,000,000 of debt, they became a debt buyer.

When the decision is made to sell off some debt, creditors usually create what are called ‘portfolios of debt’ which they then marketed to potential buyers. These portfolios are groups of debt with similar qualities such as type of debt, location of debtor, etc. In the debt buying and selling industry these portfolios are then classified by age and the number of collectors who have already attempted to collect on them.

For example, debts around six months old with no previous attempt to collect on them are considered ‘Fresh’ debts. Debts that are up to 12 months old, where at least one third party collector has attempted to recover on the account are considered ‘Primary’ debts. ‘Secondary’ and ‘Tertiary’ debts are between 18 months and 30 months old, respectively, and usually have had multiple third party collectors attempt to recover them already. After that, the names vary greatly.

Just like produce at the market, the fresher the debt, the more valuable it is, and that value also depends on the kind of debt. Naturally, credit that is extended that is backed by collateral like a mortgage, or a car loan where the creditor holds the title to the car, have the most value because the creditor can foreclose on the house or repossess the car if the debt isn’t paid. Other creditors aren’t so lucky, but these routine sell-offs have created a vast market for unpaid debts. And not just credit card debts, but also uncollateralized auto loans, medical debt, gym fees, payday loans, overdue cell phone bills, old utility payments, even delinquent book club accounts, and just about anything else where are you signed your name and promised to make some payment over time, regardless of how small.

A mind-bending number of variables impact a debt portfolio’s true value in the marketplace — the age of the debt, how many agencies have tried to collect on it, the size of the balances, the type of credit issued, where the debtors live, and the current economic climate. Some are looked at as having low odds of collecting anything and therefore worth far less to a debt buyer

Even when a creditor wins a judgment, it can be difficult to collect the money.

When someone buys these debts, they become the creditor and the original creditor can write off all or some portion of those debts from their taxes as a loss.

The price for such debts varies widely because in different states the statute of limitations that spells out the time frame that a creditor can actively pursue collecting on those debts varies. Usually, that timeframe is between three to six years but in some states it’s as high as ten or even fifteen years. The clock starts when you go into default, generally meaning when you stopped making regular payments. Again, the older the account and the more times others have tried to collect on it unsuccessfully is how these debts are priced.

In debt buyer parlance these accounts are called ‘paper’. If the paper’s age is less than three years then the general price range is somewhere around 8 cents on the dollar meaning if you owed $1,000 to a creditor and someone else buys your paper within three years of you being in default, they might pay just $80 for the ability to collect $1000 from you. Logically, if they are successful, that becomes a quite lucrative business, since their gross profit might well be $920 on an $80 investment.

That potential profit margin is why the debt buying industry has grown like Kudzu in the South.

In August of this year, Encore Capital, the largest debt buyer in the US, announced that it had doubled its previous record for earnings in a quarter. Investment analysts predict Encore will easily pass $200 million in profit this year and reward its stockholders with a 40% earnings growth compared to 2019. Portfolio Recovery, Encore’s biggest competitor is set for similar growth.

On average, according to the FTC, they paid about 4.5 cents on the dollar for the debts they acquired. On the low end of the scale, debts that are between six and fifteen years old sell for around 2.2 cents on the dollar. Many, that have been passed down the food chain from one company to the next, are sometimes purchased for less than a penny on every dollar of face value.

What makes some of these debts so hard to collect is not just who or where the debtor is, but the fact that once they reach a certain point (usually six or seven years old) they may be so old that they no longer have any impact on the debtor’s credit score (if they appear on their credit report at all) and so the debtor has no real incentive to ever pay them back.

So, when Dave Ramsey says his company bought $10 million dollars worth of debt, what did he actually buy and what might Ramsey Solutions have paid for it?

Based on information from his own website, Dave says they bought “medical and car debt” of 8,000 people from two specific private collection agencies. So, what kind of clues does that give us?

Chances are near 100% that the car debt that Ramsey Solutions bought didn’t have any title liens attached to them. We already know that medical debt is often one of the hardest to collect on, which makes them far less valuable than say, mortgage debt or student loan debt, or actually even credit card debt. We also know that the average value of the debt of the 8,000 people we’re talking about is around $1,250 per account — not a lot of money since, on average, Americans carry over $6,000 in just credit card debt alone, according to the 2019 Experian Consumer Credit Review.

And while in a real sense, Dave may personally be incredibly generous, his team at Ramsey Solutions isn’t stupid.

It only took me a couple good contacts and a few hours to find a company willing to sell me 5,000 accounts with a face value of $5,000,000 (meaning an average debt of $1,000) for a total of $75 grand, meaning a penny and a half on the dollar. No negotiating, no real care about the age or kind of account. I didn’t actually buy it, I was just trying to get a feel for how hard they are to find. It was pretty darn easy.

I’ll wager that Dave’s team spent a lot more time than I did looking for a bargain, since the plan was to forgive the debt anyway, why pay more than they had to?

I’m going to guess, just based on what I already know about the kind of debt they bought and who they bought it from, that the $10 million worth of debt that Ramsey Solutions bought were accounts that had been sold at least 3 times (meaning 3 or more companies had tried to collect and were unsuccessful) were at least 7 years old (maybe much older) meaning there was no incentive for the debtor to ever pay them back since they no longer likely even appeared on their credit report unless there was a judgment attached to it, and were purchased from companies that had relegated these portfolios to what I’m told is the ‘crap paper’ pile. In other words, they were probably happy to get them off their books.

What’s the probable price range for $10 mil of ‘crap paper’? Around between $50–100,000 dollars. Maybe less. Not even remotely close to the $10,000,000 that most people, who don’t know any better, will assume. Smart, Dave. Very smart.

But wait, you say that still means that even if it was just $50K, Dave spent his own money to pay off 8,000 peoples’ debt, that’s still incredibly generous!

Ya think?

Let’s investigate this just a little more.

First, let’s give Dave the benefit of the doubt and say his intentions were well-meaning. I like Dave. I disagree with his ideas about insurance and best practices of investing for the future but there is no question that he is the P.T. Barnum of getting out of debt and his methods have taught thousands upon thousands of how to manage their money better. No question. Hands down. Kudos all around.

But was THIS really an act of pure generosity as Dave would lead us to believe “in the spirit of Christ and Christmas”? Yeah?

Well no. Sorry Dave. I’m not gonna let you slide on this one.

First, it’s not Dave’s money. It’s not like he took $65 grand out of his personal bank account and paid off everyone’s Christmas layaways like a Secret Santa did at a Bristol, Tennessee, Walmart earlier this month — we all get that, it was his company’s money — which means it was a business expense and probably fully deductible from his company’s bottom line on their taxes — likely under the category of advertising!

Meaning, it didn’t really cost him, or his company, a dime to do this. In fact, the publicity it generated and the interest in his company that just the social media hype brought was incredibly valuable advertising they didn’t have to pay for. Smart Dave. Again, very smart.

But still, he paid off a whole bunch of people’s debts, that’s still generous even if it didn’t cost him anything, right?

That might ring true if the kinds of debt Dave’s stunt paid off were actually meaningful.

Had he found 1,000 families in his flock of millions who have partaken of Financial Peace University (FPU) whose homes were in danger of foreclosure due to the unexpected unemployment of the breadwinner due to this pandemic and paid off up to $100,000 in mortgage debt each — that would have been meaningful.

Or paid off a total of $10,000,000 of some of the back-breaking student loans for 10,000 people — that would have been meaningful.

Paying off debts that the debtor probably didn’t plan on ever repaying, very likely was no longer a credit issue for them, and may have completely forgotten about? Not so much.

Neither of the two ideas mentioned above would have been hard to do since Dave has minions of “coordinators” guiding people through his FPU in small groups where nearly everybody knows each other. However, either one of those strategies, or a hundred other ways to make a real difference in someone’s life, would also have cost Ramsey Solutions closer to that actual $10 million dollar mark since mortgage banks and the Feds (who now own 99.9% of student debt) are unlikely to sell that debt for pennies (or less) on the dollar.

So what? They saved a bunch of money and got some publicity out of it. Big deal. He still paid off some debt that helped people. Lay off him. Right?

Um…maybe not.

You see after Dave bought the debt, he could have simply (and anonymously) chosen not to pursue it any further. Chances are nearly 100% that they weren’t still on the debtor’s credit report anymore anyway. It could have simply disappeared into a file drawer never to be heard from again. No harm, no foul. All you debt and tax experts, please correct me if I’m wrong. But instead, Dave chose to use this pay-off as a publicity generator by forgiving the debts.

That, my friends, opened up a whole ‘nother can of worms.

Any type of debt forgiveness (except bankruptcy) almost always results in higher taxable income for the debtor. Unfortunately, the Internal Revenue Service considers all or most of forgiven debt or cancelled debt as guess what…taxable income. And since we know that the average debt that Dave paid off was over $1,000, then each of these 8,000 recipients of Dave’s “generosity” that had $600 or more forgiven, will receive a 1099-C tax form, that they will have to include with their 2020 taxes, courtesy of Ramsey Solutions (the creditor).

Wait…maybe Dave paid that off too?

Nope. We know that from the FAQs on his “Forgiven” page, one of which specifically asks: Did you pay also pay taxes for my cancellation of debt income?

And the answer: No, we are not responsible for paying the taxable income on your debt payoff.

But you are responsible for very publicly putting these people on the IRS’s radar, Dave, and they’re not as forgiving.

We are also given another clue as to the kind of debts that Dave bought from the FAQs themselves.

One question reads: I had no plans to pay off this debt. Can I use the money to pay my student loans, credit cards or another debt?

The answer is no, of course, they explain that they’ve already “paid off THIS specific debt.” But that tells us that these debts were probably the kind that were old enough that people were simply ignoring any (likely non-existent) effort to collect on them until (if they weren’t already removed) they would drop off their credit file entirely — meaning they must have been flat out dirt cheap to buy.

In addition, we know that Dave’s team called these people (probably multiple times) starting in November and didn’t get a whole lot of people they could use as “testimonials” or we probably wouldn’t be seeing this on that Forgiven page.

More than likely, the people they did speak to were probably baffled at first and if they did recognize the debt Dave’s team had paid off, maybe not as open to hearing the benefits of the “biblically based, commonsense education and empowerment” sales pitch opportunity that I’ll wager wasn’t overlooked by Dave’s call center team when someone actually answered the phone.

The bottom line is that this was a full-on, well planned, multi-channel publicity and marketing strategy, meant to get in front of people who may not already know about Dave Ramsey, very slyly disguised as a generous act of giving at Christmas.

Instead of leaving these debts to simply disappear into history without any fanfare, or choosing some actually meaningful debts to forgive, Dave Ramsey and crew, almost without a doubt, just gave 8,000 people a brand spanking new tax liability of at least $125, maybe as much as $225 (depending on their current tax bracket) as a Christmas present. And used his religious beliefs as a backdrop in doing so.

If it were me? I’d be seriously pissed.

Shame on you, Dave. Shame on you.

This article first appeared on Medium on December 12, 2020