What is Credit Counseling?
Credit counseling is the education of consumers about how to avoid incurring debts that cannot be repaid. Credit counseling also involves establishing an effective debt management plan (“DMP”) and budget. Credit counseling primarily focuses on establishing a planned method of debt relief, typically through a debt management plan.
Credit counseling often involves negotiating with creditors to establish a DMP for a consumer. A DMP is designed to help you repay your debt by developing a repayment plan with the creditor. DMPs, set up by credit counselors, usually offer reduced payments, fees and interest rates to the client. Credit counselors refer to the terms dictated by the creditors to determine payments or interest reductions offered to consumers in a debt management plan.
Common features of DMPs
Once a customer agrees to work with a credit counselor, the creditors will close their credit card accounts to restrict the accounts to future charges. The credit counselor will negotiate reductions in monthly payments of each of their credit card accounts and seek to have the creditors freeze the interest on accounts to keep the balance from growing. Then the credit counselor will consolidate all of the customer’s negotiated monthly payments into one monthly payment, which is usually less than the sum of the individual payments previously paid by the customer. The credit counselor will then use the proceeds of your monthly payment to make individual payments with each of your creditors based on a negotiated amount. Credit cards issuers will usually accept a lower monthly payment from a customer in a DMP than if the customer were paying the account on their own. Some DMPs advertise that payments can be cut by 50%, although a reduction of 10-20% is more common.
A customer with a defaulted credit card account will often be paying an interest rate approaching 30%. Upon joining a DMP, the credit counselor will seek to have the credit card issuers lower the annual percentage rates charged to 5-10%, or eliminate interest altogether. By doing so, a credit counselor can attempt to get the customer debt free in 3–6 years, rather than the 20+ years that it would take to pay off a large amount of debt at high interest rates.
Lastly, credit counseling agencies can also help to bring customer’s delinquent accounts current; a process known as "re-aging" or "curing" an account. To do this, credit counseling agencies must first make a series of on-time payments through the DMP as a show of good faith and commitment to completion of the program. For example, assume a client has an account that requires a monthly payment of $50, which has not been paid in two months might be considered by the creditor to be 60 days past due. After making three consecutive monthly payments in a DMP, the creditor could consider to re-age the account to reflect a current status. Thereafter the monthly payment due on the statements would be the monthly payment negotiated under the DMP, and the credit report would report the account as current to the credit bureaus. It is important to note that this will not eliminate the prior delinquencies from the credit bureau reports. It simply provides a fresh start and an opportunity for the client to begin building a positive credit history.
Criticisms of credit counseling
Over the past twenty years, there have been many concerns and complaints against the credit counseling industry. By the early 1990s, certain credit counseling organizations were so abusive it led to criticism of the entire industry.
A credit counseling agency typically gets the bulk of its revenues from the creditors with which they are negotiating repayments under a DMP. The creditors pay credit counseling agencies a percentage of the amount recovered. This is known as the “Fair Share” model. As a result of this relationship, many people believe that credit counseling agencies are merely a collection agency for the creditors.
It is clear that such a relationship can lead to conflicts of interest between credit counseling agencies and creditors. In fact, several credit counseling agencies had faced lawsuits from The Federal Trade Commission. The FTC continues to urge caution in choosing a credit counseling agency. It is reported that the FTC has received more than 8,000 complaints from consumers about credit counselors, many concerning high or hidden fees and the inability to opt out of so-called “voluntary” contributions. It is also reported that the Better Business Bureau also reports high complaint levels about credit counseling.
It’s been noted that the IRS also has come out against credit counseling by denying nonprofit 501(c)(3) tax-exempt status to around 30 of the nation's 1000 credit counseling agencies. Thirty may seem like a small number out of 1,000 credit counseling agencies, but those 30 credit counseling agencies reported account for more than half of the industry's revenue. Audits of non-profit credit counseling agencies by the IRS are ongoing.
Some assert that participating in a credit counseling DMP will ruin a consumer’s credit. FairIsaac Corporation, the company that pioneered the use of credit scores, states that participation in a DMP has no effect on a consumer's credit score. However, consumers should note that fact that you are participating in a DMP may appear on consumer credit reports, and the consumer may have more difficulty obtaining credit for basic items such as a car or home loan a credit card. This is because lenders tend to consider multiple risk factors to determine creditworthiness. Some lenders view a prospective customer's participation in a DMP as indicative of the customer being unfit to manage their finances.
Given this criticism, this industry should cause consumers to think two or three times before deciding on hiring a credit counselor. It appears that this industry, in its current form, will continue to be scrutinized by both the consumer and government regulators over how they will be paid for the services they perform. In meantime, there will be no shortage of debt-burdened consumers who now have a better alternative, RRL Finance.