Credit counseling is a process that helps indebted consumers manage their debt while providing them with the financial skills they need to avoid taking on more. Credit counselors typically work with individuals who are behind in their payments by establishing a payment schedule that allows them to regain control of their finances. Anyone considering bankruptcy is required to undergo credit counseling first.
Credit counseling comes in all shapes and sizes. Some agencies are nonprofit, while others are for-profit. Some are funded by creditors; others are funded by user fees. One credit counselor may suggest a debt management plan, while another may point a consumer toward debt consolidation.
It’s important for consumers to know what credit counseling is and how to find a professional whom they can trust.
How Credit Counseling Works
At an initial credit counseling session, which usually lasts at least one hour and can take place in person or over the phone, a credit counselor will review a consumer’s financial situation and provide possible solutions, which likely will include a spending plan and a plan to repay creditors. For those with considerable debt problems, a debt management plan (DMP) or debt consolidation may be discussed as viable debt-relief options.
Debt Management Plan
With a DMP, the counselor will negotiate with lenders to try and lower a debtor’s interest rates or have certain fees, finance charges and/or penalties waived. Interest rate reduction and fee forgiveness can substantially lower a debtor’s monthly payments.
Money is then deposited each month with the credit counseling organization, which is now responsible to pay all unsecured debts, like credit card bills, student loans and medical bills, according to a payment schedule that the counselor develops with the debtor and his or her creditors. By consolidating all debt payments into one monthly payment, a consumer simplifies his or her debt obligations.
Credit counseling for consumers who are having trouble paying their debts may also include a discussion of debt consolidation. Again, the financial professional will negotiate with the creditors, which could result in a lower principal balance. That means consumers can settle their debts for less than they owe.
Money is deposited each month into a special account. The first debt is settled when there is enough money in the account. The debtor continues to set aside money each month to settle the second debt, and so on. The consumer makes just one monthly payment, thus simplifying his or her debt obligations.
Credit Counseling Costs
The credit counseling industry began decades ago with the support of creditors, who wanted to be able to collect debts that had gone bad, while helping to prevent their recurrence. The lenders paid fees to agencies, to help finance the business of advising consumers, providing them with budgeting and financial literacy courses and workshops, and assisting them in the creation of debt management plans (DMPs).
Over the years, however, creditors began paying less and less to the agencies, which then started charging consumers for their services. Today, credit counseling agencies are funded through a variety of sources, including contributions from creditors, grants from private sources and foundations, and client fees.
Reputable firms will disclose their fee structure up front, so consumers know what they are agreeing to. Details of any debt-relief program, as well as the fees associated with it, should be presented to a consumer in writing.
Choosing the Right Credit Counseling Agency
Many credit counseling companies are affiliated with the National Foundation for Credit Counseling (NFCC) or the Independent Association of Certified Counseling Agencies (IACCA). Other credit counselors may be associated with the International Association of Professional Debt Arbitrators (IAPDA). The agency should be licensed to offer services in the consumer’s state of residence.
Everything between the consumer and the agency should be formalized in written agreements or contracts, with assurances that all personal and financial information is kept confidential and secure. If the agency does not agree to deal responsibly and effectively with all matters relating to the services it provides, it is advisable to look elsewhere.
Legitimate credit counseling agencies work with millions of consumers every year, helping them create and sustain financial stability, teaching them how to manage their financial lives and, most importantly, working with them and their creditors to develop practical plans that will eventually free them from crushing debt.