Credit Counseling Facts and FAQs

One way or another, most consumers have heard of "Credit Counseling," but most are unaware of what exactly it means. This article will allow readers to help decide whether or not Credit Counseling is right for them, how to pick a company, what questions to ask, and what impact it will have on credit.

What is Credit Counseling?

Credit Counseling has actually been around since before credit cards. The first Credit Counseling agencies appeared on the scene in 1950. They were founded and run by the creditors as a way to help their customers pay off debts.

Through word of mouth, the news about this type of service spread, and before long chambers of commerce and business leagues across the United States were setting up local Credit Counseling agencies in their communities. More often than not, these agencies were located in banks.

Counselors provide a complete budget and credit analysis and education at no charge. For most who speak with a counselor - about 40% - the counseling aspect alone is enough to solve their financial concerns.

The primary tool of a modern credit counseling agency is known as a Debt Management Plan (DMP). The agency already has specific guidelines setup with creditors that allows them to lower interest rates and set new monthly payments. All major creditors work with credit counseling.

The consumer will then pay one monthly payment to the counseling agency as a part of a debt management plan. The agency will then disburse the funds to the creditors. Because the payments are coming from a counseling agency, the creditors agree to the concessions.

That is the basic gist of it, but there is so much more.

What types of debt can Credit Counseling help with?

The first thing to understand is that only unsecured lines of credit are eligible to be placed on a DMP. Examples of unsecured credit include, but are not limited to, credit cards, personal loans, medical bills, collection accounts, unpaid utilities, payday loans, and loans from friends or family. These types of debt can be handled by a counseling agency.

Secured loans are not eligible and cannot be placed on a DMP. Examples of secured loans included, but are not limited to, mortgages, revolving lines of credit secured by property, home improvement loans, auto loans, recreational loans, and bills for utilities that are still connected.

Who should Use Credit Counseling?

Credit counseling is not for everyone. Debt management plans are specifically designed to benefit consumers who have high interest rates, are near their credit limits or are over the limit, or who can't afford to make more than the minimum payments.

The ultimate litmus test is this: Ask yourself if you see your debts decreasing month to month. If it feels like you're getting nowhere, it might be a good idea to call a counseling agency.

How does a Debt Management Plan work?

As a result of counseling, the counselor will provide a list of possible options to handle the debt. Typically, that list includes continued self-management, sell or borrow against assets, seeking legal advice regarding bankruptcy, or initiating a Debt Management Plan.

As previously mentioned, all major creditors have deals already set up with legitimate counseling agencies in regards to setting payments and interest rates. For example, Citibank's deal is that the interest rate will drop to 9.9% and in return they will require a monthly payment of 2.25% of the what total balance was at the time that the DMP was implemented, for the duration of the program.

Other creditors, such as Discover and MBNA America determine internally the level of interest rate concession that they will provide on a case-by-case basis.

Small creditors, such as collection agencies, payday loan companies, and local credit unions may need to be contacted by the counseling agency to determine if they will participate, and if so, what concessions they are willing to offer.

Once the payment is determined, the consumer will provide the counseling agency with records of their debts, usually in the form of statements. The counseling agency will then determine a monthly payment that encompasses the minimum required payments from each creditor and any associated agency fees.

The consumer will then make the same monthly payment throughout the duration of the plan. An average plan lasts 45 months regardless of the amount of debt, a breakneck fact pace. Most creditors do not allow a plan to last more than 60 months.

During the plan, the payment will never be reduced, despite the fact that some creditors will be paid off before others. The reason for this is, as one creditor pays off, the amount of the payment allotted to that creditor will be pro-rated to the other creditors. For this reason, a DMP is able to pay off debt in an extraordinarily fast pace.

How will Credit Counseling affect my credit?

First of all, counseling agencies are not creditors, they do not report to any credit bureau. So, simply consulting an agency cannot affect one's credit, whatsoever.

However, all major creditors do report, to all three national credit bureaus, usually on a monthly basis. The creditors will like add a notation to their specific trade-line on the credit report stating that the account is being handled by a credit counseling service.

The note is intended to discourage lenders from granting the consumer additional lines of unsecured credit, which they don't need in the first place. The note does not usually affect a borrower's ability to obtain a secured loan, such as a mortgage or car loan.

Many consumers may testify that they could not receive a secured loan while participating on a DMP, but that is likely because significant damage to their credit history had already incurred prior to their participation.

This note, which typically is stated "Account handled by CCCS" or "Account on DMP," is only a status note. This means that the notation must be removed either when the consumer completes the DMP, or elects to terminate a plan.

By the time the DMP has run its course, a consumer's credit record will look better than ever, having paid off a significant amount of bad debt or revolving credit. Studies from the University of Indiana indicate that credit scores begin to increase after the first six months. This is due to debt reduction and consistency in payments.

How do I choose a company to work with?

· Make sure that the counseling agency you decide to use is a non-profit organization under section 501c(3) of the Internal Revenue Code.

In the 1990's, the credit counseling industry was plagued by scams due to an antitrust lawsuit that deregulated the entire industry and allow for for-profit counseling agencies to arise. The most notable of these was AmeriDebt, which had over 60,000 clients at its peak, and advertized heavily on TV, radio, print and billboards. AmeriDebts owners, the Pukkes, ripped off consumers to the tune of hundreds of thousands of dollars. The FTC and seven states attorneys general shut down the company, and most others like it.

· Ask if the agency is a member of any regulatory body

Like most industries, the credit counseling industry has several self-regulatory entities that set standards for service for their member agencies. The most notable of these is the NFCC (National Foundation for Credit Counseling) which was founded in 1956.

With new bankruptcy laws that require credit counseling, the federal government has gotten into the business of making sure that several agencies meet the education requirements. These agencies are approved by the EOUST (Executive Office of the United States Trustee).

· Objective advice; actual counseling

Some agencies are not interested in providing education, only selling a DMP, even if the recipient does not need it. Counseling should be objective, and actual counseling should take place. This includes a full budget analysis and advice, income analysis, building a balance sheet to compare assets and liabilities, and a review of at least one major credit report (usually free).

Without discussing this information in detail neither the counselor nor the consumer can possibly be in a position to select the best option for a financial situation.

· Shop around

Counseling sessions are free. Participate in two to three counseling sessions to determine which agencies feel like they're offering sound advice and to compare agency fees.

· Did they offer to reduce your total debt?

Beware of agencies known as "Settlement Agencies" that often masquerade as counseling agencies to gain legitimacy. These agencies essentially charge money for what anyone can do for free. They first allow their client's debt become severely delinquent; many times to the point where the credit initiates legal action.

During this period, the consumer makes monthly payments to the settlement company. The settlement company usually stores invests funds in stocks or mutual funds on the open market. They then call the creditors one at a time and negotiate settlements.

Having multiple settlements on a credit report is oftentimes worse than bankruptcy. Debt settlements are never a viable option. In many cases, the unsettled amount can still be collected on. Some secured lenders, such as a mortgage, require that the unpaid balance be paid before issuing a loan.

The notation that the account was settled for less than the full balance will remain on file at every credit bureau for a term of no less than seven years from the date the action was first reported.

I thought they are non-profit. How do they get paid, and why are there fees?

Counseling agencies are non-profit, but they are not non-revenue. They have the same operating expenses of any for-profit company, and like their clients, they have to make ends meet.

A portion of an agency's revenue comes from what is called "fairshare." Fairshare is a percentage of payments paid through a DMP that are reimbursed by the creditor. Though each creditor's fareshare policies are different, the average amount of fareshare is currently 5.5%. In other words, for each dollar the agency sends to a creditor, they receive 5.5 cents back as a donation. As a contrast, fareshare was as high as 17% in the late 80's.

Agencies also charge fees. Typically a onetime setup fee and a monthly fee. The amount that they charge is regulated by state laws is most cases. There are still a few states that have no laws regarding how much an agency is allowed to charge.

In states where fees are now allowed, they ask for voluntary contributions. Running a business is expensive and fareshare doesn't cut it.

In addition to fareshare and fees, most counseling agencies also receive grants from government agencies and donations from businesses and community leaders.

Why will my creditors work with them and not with me?

A creditor's number one fear is that a borrower will default and perhaps declare bankruptcy. If a creditor offers and individual concessions on their one credit account, it does not mean that the consumer will not use their other accounts irresponsibly and force themselves into a bankruptcy situation.

With credit counseling, the creditor knows that the consumer is trying to get help, and are therefore more trusting. Some creditors, such as MBNA America, the world's largest issuer of unsecured credit, requires that a consumer include all revolving accounts on a DMP, or they will not participate.

What next?

If you are already considering credit counseling, use the knowledge that you gained to ask the right questions and to know what to expect. Your financial stability can feel like a war at times, and knowledge is the ultimate weapon.