Credit counseling is the Kleenex or Xerox of the debt help world. It has become a catchall phrase that has lost specific meaning and become a generic description of some sort of debt assistance.
For some people, credit counseling is primarily perceived as a non-profit service delivered by IRS 501(c)(3) non-profit organizations.
Modern credit counseling was born out of the intersection of problematic for-profit “debt poolers” and community-based budget counseling. Those community groups were started by local creditor groups to give advice and provide assistance to people struggling to make payments.
What began as a neighborly effort evolved into a modern hybrid of for-profit companies, opportunists who borrowed the name credit counseling, and non-profit organizations.
In the 1930s and 1940s, for-profit companies selling debt help were being closed down for taking advantage of disadvantaged consumers. Those groups had been offering advice and selling payment assistance services to help people “restore your credit without a loan.”.
The Origin of Credit Counseling
Local credit counseling began as an effort by local creditors. One of the first companies was Economy Budget Service of Columbus, Ohio. It was the brainchild of the late Leon J. Ingram, president of the Capital Finance Corp., a public-spirited 18 state, small loan company which financed and operate it entirely alone at a $15,000 annual cost for 12 years.
Another early credit counseling organization was Family Debt Counselors (FDC). FDC began in 1958 in Phoenix to assist “families to extricate themselves from debt entanglement.” The founder and director of FDC was Richard K. Steinman.
“It was Steinman, who heads a local chain of small-loan companies, with other members of a committee from the Arizona Consumer Loan and Finance Association (which put up $500) who started FDC. At first, they encountered considerable resistance. “Everyone agreed we had a serious problem with our rising personal bankruptcy figures,” Steinman says, “but few could agree on a solution and even fewer were willing to pay for it.” However, they won the support of the Legal Aid Society, the Family Service Association (a social-welfare group), banks, and the AFL-CIO Central Labor Council, which contributed $1500, and FDC was launched.” – Source
These early efforts stated their goal was to assist people to avoid bankruptcy. Credit counseling today continues that mission focus. However, it seems the stigmatization of bankruptcy fed into the underlying mission of collecting money to return to creditors. If bankruptcy was made evil, even if it made the most financial sense, then the remaining “good” option was to repay local creditor groups.
How Does Credit Counseling Work
Much has changed over the years, but one thing remains the same, credit counseling is still very tied to creditors for funding and participation in their efforts. I’ll talk about the pros and cons of credit counseling below to help you become a better-educated consumer.
Today the range of services has expanded beyond budget help and has broadened into student loan repayment advice and housing counseling as significant product efforts.
Preparing for a Credit Counseling Session
When you talk to a credit counseling group, inevitably the conversation will turn to who you owe, how much, and what does your budget look like.
The easiest way to prepare for this initial conversation is to gather the most recent statements and bills from creditors. Also, take a few minutes to write down what your monthly income and expenses are.
Most people don’t have the exact details on their budget because they don’t track every expense. But for the first meeting with a credit counselor, an overall look at where your money goes is helpful.
You need to resist the effort to understate your expenses and instead be as honest as possible. Don’t forget to add all those small extra expenses each month from the unplanned coffee, meal out, or fun trip out. It’s the little things that add up to significant costs. If you really want to get serious and prepare for the meeting with real numbers, consider taking a few weeks to track your expenses and develop a spending plan.
The credit counselor isn’t going to judge you personally because of your debts. Actually, they are going to primarily see if you can afford the solution they are selling.
What to Expect From a Credit Counseling Session
The type of service delivered by credit counselors is all over the place. Many people working at credit counseling organizations care personally about you as an individual and the struggles you are facing. Other people are commissioned or incentivized salespeople who are motivated to get you into whatever solution they are selling.
In a perfect world, the advice you will get from a credit counselor will not be dependent if they can sell you a product or service. The information should be fair, balanced, and based on facts and your goals.
Far too many credit counselors talk negatively about bankruptcy out of either habit or as a sales tool.
If you want to really prepare for your credit counseling session, take a look at the significant debt relief options out there by using my Get Out of Debt Calculator.
Choosing a Credit Counselor
It is as hard to find a good credit counselor as it is an excellent dentist when you move to a new area. Unlike hunting for a dentist, finding a credit counselor is not the type of thing people talk about with friends.
Your best bet is to do some homework first and learn the pros and cons of the primary debt relief options out there.
Then I would suggest you talk to at least three different credit counseling companies. Don’t make a rash decision about what to do. Just ask for advice and listen to what they have to say. Then take a day or so and let all that you have learned, percolate.
While picking someone who might promise you the lowest monthly payment feels right, it’s not. The first thing you should look for is if the credit counselor gave you impartial, reasonable, and balanced advice. Then you want to make sure the credit counseling company you like is friendly, professional, and easy to get in touch with.
Is It Right for You?
After all of that, you still need to contemplate if credit counseling is even the best path you should choose.
You should absolutely talk to a bankruptcy attorney, and debt settlement company as well before you make any decision about what solution is right for you.
There is no need to rush into making the wrong decision.
Each group of debt relievers will try to sell you their product. Credit counselors and debt settlement companies may tell you how lousy bankruptcy is. Bankruptcy attorneys will tell you they don’t like the other folks. But none of these solution providers are professionals looking out for your financial future.
For example, credit counselors will typically tell you to enroll in their solution to avoid bankruptcy. But they rarely calculate and show you the future financial loss of retirements savings you may experience by participating in their repayment plan.
Debt Management Plans
The original product sold by credit counselors is the Debt Management Plan (DMP) that consists of about 60 monthly payments.
This is a program where the credit counselor collects one payment from the consumer each month and cuts it up into smaller amounts which goes to the appropriate creditors.
Credit counselors earn an income from this program by keeping a percentage of the payment while the consumer gets credit for the full amount. Or the credit counselor may invoice the creditor for their “fair share” of the collected payment.
A more modern creditor funding solution has been to untie funding from the collection of the payment and award the credit counseling group some arbitrary funding instead.
Student Loan Counseling
Some credit counseling groups offer feedback and advice on dealing with student loans. Having someone help explain the differences and options between federal student loans and private student loans can be helpful.
I find many credit counseling groups fail to tell people about how to settle private student loan debt for less than is owed. When it comes to dealing with federal student loans, there are several options from getting out of default to unique loan reduction plans.
Credit counseling groups earn money from Housing and Urban Development (HUD) by providing housing counseling advice. A Housing Counseling Agency is trained to provide tools to current and prospective homeowners and renters so people can make responsible choices to address their housing needs.
While the typical sales pitch by a credit counseling group may be that you need to enroll in their services to avoid bankruptcy, these same groups may also sell bankruptcy counseling so you can file bankruptcy.
Credit counseling agencies can apply to be recognized by the Department of Justice, United States Trustee Program to provide the required debtor education course and credit counseling before bankruptcy.
Frankly, this is a joke and a waste of time. When this was included in the Bankruptcy Abuse Prevention and Consumer Protection Act (BAPCPA) of 2005, the idea was this would drive free potential customers to credit counseling groups they could then talk into enrolling in their debt management plans.
The Act states that a debtor will no longer be eligible to file under either chapter 7 or chapter 13 unless within 180 days prior to filing the debtor received an “individual or group briefing” from a nonprofit budget and credit counseling agency approved by the United States trustee or bankruptcy administrator.
A 2007 Government Accounting Office (GAO) report found little value to this new forced bankruptcy filing requirement. The GAO said, ” the value of the counseling requirement is not clear. The counseling was intended to help consumers make informed choices about bankruptcy and its alternatives. Yet anecdotal evidence suggests that by the time most clients receive the counseling, their financial situations are dire, leaving them with no viable alternative to bankruptcy. As a result, the requirement may often serve more as an administrative obstacle than as a timely presentation of meaningful options.”
As I said, it’s a total waste of time.
Credit Counseling Pros and Cons
Credit Counseling Pros
- Non-profit credit counseling groups can provide budget advice and check the budgets of consumers facing financial pressure to give suggestions.
- They can also offer some advantages in a DMP where some creditors will reduce or drop the interest rate they are charging on the debt repaid through a credit counseling program.
- The single monthly payment made by the consumer to the credit counseling group provides a benefit through simplifying making payments during a difficult time.
- Many non-profit credit counseling group employees are good people who want to be helpful.
Credit Counseling Cons
- Credit counselors tend not to provide balanced advice and think poorly about solutions like debt settlement and bankruptcy. That bias seems to disregard often other solutions that might be more appropriate.
- This steering of consumers occurs not because credit counseling staff are mean or deceptive but because they believe in what they are doing to such an extent or trying to bring in business that they develop a subconscious bias against solutions they don’t offer.
- I’m very concerned about consumers entering DMPs to repay their debt and forgoing solutions that would help them build emergency savings accounts and retirement savings faster.
- While credit counseling groups are critical and speak about other debt solutions they are silent when it comes to the effectiveness and success rates of the DMP.