Consumer credit counseling is one of the options people turn to when dealing with debt issues so let’s take an honest look at the pros and cons of the program and what it has to offer.
Consumer credit counseling in one form or another has been around as debt proraters, debt lumpers, or debt consolidators since the late 1930s. But organized consumer credit counseling was founded in 1951. For those interested in the history of modern credit counseling, read this article.
I could go on at length about the history of credit counseling but let’s just get to the meat and bones of modern day credit counseling.
Modern Consumer Credit Counseling
Consumer credit counseling groups are typically those organizations that are formed as non-profit entities. Most are IRS 501(c)3 non-profit educational organizations. Some try yo be sneaky and say they are “non-profit” and technically they are, but only state registered non-profit groups. In the world of non-profits, consider that non-profit “lite.”
A very common misconception people have about non-profit groups is they don’t make money. That is fundamentally not true. Non-profit groups can make a crap load of money and profit. The term non-profit refers to their tax status as charities. Since they are supposed to be serving the common good they pay no income tax on the money they make, hence non-profit.
While some credit counseling groups in general make millions, today the average credit counseling group is battling tough headwinds in making ends meet. They are pressured to make sales to generate money to continue their operation.
Credit counseling groups are educational charities but they make the majority of their income in providing services. They get paid to help with housing counseling, pre-bankruptcy counseling, and the old bread and butter program, debt management plans.
The Debt Management Plan
The debt management plan (DMP) is a program created that allows the credit counseling group to collect one monthly payment from the consumer and divide it up amongst the creditors the person owes. Sometimes they refer to this as consolidation, but it’s really not.
As compensation for doing this the credit counselor can charge a monthly fee and gets some compensation from participating creditors for collecting and returning money. This creditor compensation is called “fairshare.” Why, I don’t know.
Fairshare funding has declined dramatically to the point the average income from fairshare compensation from creditors is about 4 percent of the money collected from the consumer.
Since non-profit credit counselors are dependent on funding by creditors for this debt management plan and creditors set the terms and control which credit counseling agencies can participate, the creditor calls the shots and pulls the strings.
When a consumer is enrolled in a DMP, there is no negotiating. The terms are set by the creditor.
Many times the consumer can call their creditors and get more favorable terms directly and not have to pay any monthly fee to do that.
Since credit counselors are beholden to the creditors when it comes to the DMP, the demand of creditors is effectively to not put the consumer first. The consideration by the creditor is a business decision and not one that creates a solution that is either moral or ethical for the consumer. Yet consumers often to decide to enroll as a moral decision and not consider the math as a family business decision.
For example, many credit counselors try to talk consumers out of bankruptcy or to reinforce the assumptions the consumer has about bankruptcy in an effort to enroll them in the DMP. Bankruptcy can often be the better financial solution since the debt can be eliminated in 90 days rather than five years.
Another example of the conflict between enrolling someone in a debt management program first is the undisclosed future cost to the consumer by participating. See my debt repayment calculator below.
Debt Repayment Calculator
This calculator demonstrates the future retirement financial loss you may experience when electing to repay your debt with an extended repayment program offered by creditors, credit counseling or debt settlement, rather than intervene on your debt with solutions like bankruptcy which terminate the debt quickly and allow you to resume saving again for retirement.
The calculator solves two problems.
Cost of Payment Plan in Retirement Dollars: This is the value of the retirement funds that you could have invested rather than repay your debt through an extended repayment program.
Future Lost Retirement Value: This is the amount you will lose in retirement from entering into a repayment plan to deal with your debt.
If you want to just see the amount lost from the payment plan, leave the “Monthly Payment After Payment Plan” box at 0.
Here is an example:
Current Age: 25
Monthly Payment: 300
Monthly Payment After Payment Plan: 0
Length of Payment Plan: 5
Rate of Return: 10
Estimated Retirement Age: 70
Cost of Payment Plan in Retirement Dollars = $23,231.12
Retirement Cost of Payment Plan = $1,247,526.55
What This All Means
If you elected to pursue some other solution, like bankruptcy, to discharge your debt quickly, you would not make monthly payments into an extended repayment plan. Those funds could instead be used to save towards retirement.
In this example, if our 25 year old debtor decided to enter into a credit counseling or debt settlement program they would repay their debt but that plan would cost them $23,231.12 in retirement funds that would be worth $1,247,526.55 when they eventually retired.
The purpose of this calculator is to not talk you out of credit counseling or debt settlement but to assist you to make a more informed decision about the future costs to you.
Current Age: Enter your current age.
Monthly Payment: Enter monthly payment of debt plan.
Monthly Payment After Payment Plan: Enter any payment you expect to make on a monthly basis into your retirement plan after you get out of debt. Leave this as 0 if you just want to see the future cost of lost retirement from a repayment plan.
Length of Payment Plan: Enter the number of years the repayment plan will take.
Rate of Return: Enter the rate of return you anticipate your retirement plan to have. Keep in mind that a good stock index mutual fund can return 10% or more.
Estimated Retirement Age Age: The age you anticipate retiring at.
And if you don’t think worrying about saving for retirement is important, please read The Saddest Avoidable Mistake People Make When Getting Out of Debt.
Why This is Important
Government data shows 41 percent of Americans aged 55-64 have no retirement savings account.
For those in this age group who do have a retirement account, the median account balance is only $103,200. In addition, an increasing number of Americans are retiring without pensions.
The Employee Benefit Research Institute (EBRI) finds that 44 percent of baby boomers will fall short of adequate retirement income for basic expenses and uninsured health care costs.
Women, in particular, have an increased likelihood of outliving assets due to, among other things, lower savings and lower private pension coverage. – Source
You don’t want to wind up broke in retirement.
The Inherent Conflict Between Credit Counseling and Consumer Needs
Having founded and run a large credit counseling group myself I have some first-hand experience from inside the credit counseling industry.
Credit counseling front line workers are mostly unaware and management will be silent about this but for the most part there is an underlying tension and need to keep enrolling people in a DMP so the credit counseling company can make money.
This create a fundamental conflict between the needs of the agency and the needs of the consumer. See this article for more on that.
If the credit counseling company did not strive to enroll consumers in their DMP or make money, they would go out of business. So for most, the internal goals, conversions and quotas are necessary to run a viable consumer credit counseling agency.
It is what it is. The main takeaway from that point is that while the credit counseling group may be the kindest, most skilled, and professionals of the highest caliber, the consumer still needs to filter the advice and messages they hear through a sales filter.
Credit Counseling Program Offers Some Advantages
Modern credit counseling offer some advantages for the narrowing niche of suitable consumers.
For people who can easily afford the monthly minimum payment the creditors ask for, can also continue to save for retirement and their emergency fund, and who don’t care their credit cards will be closed, then the interest rate reductions and single monthly payment might be attractive.
Enrolling in a credit counseling program can lower the monthly payment a bit, especially if you are behind. It can also lower the interest rate you will pay as determined by the creditors.
Generally after one to three payments into the DMP, collection calls will stop and any delinquency will be brought current on the credit report.
The Big Gotchas
Credit counseling can not manage all debts. Not all creditors participate in a credit counseling program. Typically only unsecured creditors are enrolled.
People also will emotionally enroll in a DMP to make the pain of collections go away. But they do this sometimes without thinking of the future cost to them in lost retirement. (See the calculator above.)
Enrolling in a credit counseling program can lower and hurt your credit score. See this article for details.
A credit counseling program generally lasts five years and your debt is not gone until you pay it all off. If something unexpected comes up during the repayment you may be kicked out if you default on the payment and still be in debt.
Credit counseling can be expensive. At $50 per month a five year program will cost you $3,000 in just monthly fees. So let’s put that into context. A credit counseling program will take five years and cost about $3,000 plus interest paid. A chapter 7 bankruptcy will take 90 days and cost a fraction of that amount and allow you to start rebuilding your credit immediately. To learn more about bankruptcy, click here.
Credit counseling is less effective than you would imagine. In general the vast majority of people that enroll in a credit counseling program do not repay all of their debt through the program.
If you want to hear a credit counselor start stammering, demand to see the written performance data for the agency so you can confirm their measured success rate.
(If you want an example of what to ask for, see the information Cambridge Credit Counseling provides.)
If you are thinking of using credit counseling, I’d suggest you first read How to Get Out of Debt. The Honest and Unvarnished Truth, How Do I Get Out of Debt Quickly? Change Your Mindset, and The Truth About The Success Rates, Failure Rates and Completion Rates of Credit Counseling, Debt Settlement, and Bankruptcy. They will give you a great overview of what we need to deal with to get you moving in the right direction.
Then use the free How to Get Out of Debt Calculator to review your options.
Once you’ve identified a company you want to work with, then follow my step-by-step guide on what you should look for and expect from a good debt relief company.
If you are thinking that a credit counseling program is the way to go for some moral reason, that’s fine. All I ask is that you first understand the math and your future goals. You also need to decide if you want to spend the next five years repairing the past or working to fix the future.
Educate yourself about all the debt relief options and then decide what path is best for you moving forward.