What Is Credit Counseling?
Credit counseling provides consumers who may feel overburdened by debt with guidance on consumer credit, money management, debt management, and budgeting. The goal of most credit counseling is to help a debtor avoid bankruptcy if they find themselves struggling with debt repayment.
Many counseling services will negotiate with creditors on the borrower’s behalf to reduce credit card and loan interest rates and waive late fees. According to the Consumer Financial Protection Bureau (CFPB), credit counseling agencies most often operate on a nonprofit basis, although there are credit counselors that are for-profit.
Key Takeaways
- Credit counseling helps consumers with consumer credit, money management, debt management, and budgeting.
- One purpose of credit counseling is to help a debtor avoid bankruptcy if they are struggling with their debt burdens.
- Counseling services negotiate with creditors on the borrower’s behalf to reduce interest rates and waive fees.
- A credit counselor can also discuss debt repayment strategies to help you choose a method that works best for you.
How Credit Counseling Works
Credit counseling is an option for consumers who can't manage their debt when it becomes too overwhelming. In most cases, these borrowers can make at least the minimum payment, unlike those who are on the verge of bankruptcy. The goal is to get back on track by working with a credit counselor to come up with a manageable financial plan and pay off their financial obligations. It also helps borrowers come up with budgeting and debt management skills.
Reputable credit counseling organizations employ trained and certified staff. These counselors can talk with clients to help them develop a personalized plan for their credit issues. An initial counseling session typically lasts one hour, with an offer of follow-up sessions. A reputable agency should offer information about its services free of charge without requiring potential clients to disclose details about their situation.
Credit counseling companies can help you create a debt management plan (DMP), which allows you to make a single payment toward your debt each month. Under aDMP, the consumer deposits money each month into an account held within the credit counseling organization. The organization uses the funds to pay unsecured debt, such as credit card bills, student loans, and medical bills.
These debt payments follow a schedule that the counselor and the consumer develop together. Creditors often need to agree to the scheduled repayment plan, and in some cases, they may decide to lower interest rates or waive fees. A successful DMP requires regular, timely payments. It may take 48 months or more to complete aDMP.
If you’re considering debt settlement, be wary of companies that ask for an up-front fee or service charge. The Federal Trade Commission (FTC) imposes certain requirements that must be met before you can be charged a fee for debt settlement services.
Credit Counseling Services
There are manynot-for-profitcredit counseling groups that offer services in person, online, and via telephone. Many universities, military bases, credit unions, housing authorities, and branches of the U.S. Cooperative Extension Service operate nonprofit credit counseling programs. Local financial institutions and consumer protection agencies also may be good sources of information. However, nonprofit status does not guarantee that services are free, affordable, or legitimate.
Some credit counseling organizations charge high fees, which they may hide. Others may urge clients to make contributions to their charitable organization.When considering any credit counseling service, it’s important to understand what fees, if any, you may be charged and what those fees are for.
Bankruptcy can be extremely damaging to your credit, so it’s important to explore every option for managing debt before choosing this option.
Credit Counseling and Debt Management
Credit counseling can help with getting out of debt, depending on your situation and your needs. For example, if you’re struggling to come up with a realistic budget, then a credit counselor can review your spending and income and help you identify areas where you could improve and create more money to apply to debt repayment.
A credit counselor can also discuss debt repayment strategies to help you choose a method that works best for you. For example, they may help you weigh the merits of the debt snowball method versus the debt avalanche method. Both methods require you to prioritize your debts and pay as much money toward the first one as possible while paying the minimum to the rest of your debts.
Where they differ lies in how you order your debts. With the debt avalanche, you pay off debts from the highest interest rate to the lowest. This method can help you save money on interest over time. With the debt snowball, you pay off debts from the lowest balance to the highest. You may not save as much on interest, but you can get motivated to keep paying down debt if you’re able to clear one or two balances relatively quickly.
Whether a credit counselor is an effective way for you to pay off debt depends on what you can afford to pay, based on your income, your budget, and your overall financial situation. For example, if you can’t afford to pay your debts monthly, but you do have some money in savings, then you may consider debt settlement instead. And in a dire financial situation, bankruptcy may be the last resort.
If you’re concerned about a credit counseling agency’s reputation, consider contacting your state attorney general’s office or state consumer protection agency to learn whether a particular company has had any complaints filed against it.
Help Finding a Credit Counselor
The National Foundation for Credit Counselingis a nonprofit that connects consumers with nonprofit credit counselors. The U.S. Trustee Program keeps a list of credit counseling agencies approved to provide pre-bankruptcycounseling. Bankruptcy law mandates that anyone filing for bankruptcy must first undergo credit counseling.
As you search for a credit counselor, there are certain questions to keep in mind that can help you find someone reputable with whom to work. Some of the most important things to ask include:
- What services do you offer?
- How is credit counseling offered at your organization?
- How often will we meet or communicate?
- Do you offer free educational resources?
- What fees, if any, do you charge?
- What if I can’t afford to pay?
- Do I have to sign a contract to use your services?
- What are your certifications and qualifications?
Asking these kinds of questions can help you make a more informed decision about which credit counseling agency you’d like to work with.
Advantages and Disadvantages of Credit Counseling
Credit counseling may be a blessing for some borrowers. But keep in mind that there are certain drawbacks to using this type of service. We've highlighted some of the main pros and cons of credit counseling below.
Advantages
The main benefit of entering a credit counseling program is that you're getting the help you need. Budgeting, managing spending, and controlling debt can often be daunting for many individuals—especially when times get tough. Being guided by a financial professional who can help you through a repayment plan can help you get back on track and build a plan for a better financial future.
As noted above, a debt repayment plan involves depositing a lump sum with the credit counselor each month. Payments are made to your creditors from that account as per the plan. This means that you only have to make one payment to a single place rather than multiple creditors all at once.
Creditors often want to work with borrowers to get their debts repaid. So, in many cases, you may find that counselors can lower interest rates to pay off your debts faster, and they may be able to get (late) fees waived.
Disadvantages
One of the main disadvantages of using credit counseling is that it may affect your credit report. Some agencies may put a comment on your report that indicates you are on a debt management plan through credit counseling. This means that creditors may see this when you apply for new credit, or if you want to extend any existing credit limits. Some lenders may turn you down if they see this on your report. Be sure to ask the credit counselor what the implications are before you sign up.
Accounts that are deemed part of the debt repayment plan have to be closed. This may help you from accruing additional balances, but the downfall is that you may not be able to access any additional available credit even when you have an emergency.
Pros
Free and low-cost help with managing finances and paying off debt
Debt management plans only require a single monthly payment
Possible to get interest rates lowered and fees waived
Cons
Note added to credit report for using a debt management plan
Accounts may be closed, eliminating any available credit
Credit Counseling vs. Debt Settlement vs. Debt Consolidation
It’s important to note that credit counseling and agencies that provide these services are not the same as companies that offer debt settlement or debt consolidation services. These two services may share some similarities, but they are different.
Debt settlement involves the negotiation of a reduction in the total amount of debt owed. This is something that you can either do on your own or you can hire a debt settlement company. The latter option typically involves a fee. Debt settlement can help you eliminate debts for less than what’s owed and avoid bankruptcy, but it can have negative consequences for your credit score.
Debt consolidation is a process in which you take out a consolidation loan to pay off all of your existing debts. Then you would make payments toward the new loan going forward, according to the interest rate and terms set by the lender. This method doesn’t allow you to pay less than what’s owed toward your debt, but it can make repaying what you owe more streamlined and convenient. Consolidation is also a lot kinder to your credit score than debt settlement.
When Should I Seek Credit Counseling?
Credit counseling offers borrowers a way to repay their debt through a credit counseling agency. It also offers advice regarding your debt and broader financial situation. You should consider credit counseling and debt management plans when your debt is overwhelming and you can't manage your debts. In most cases, you can at least make the minimum payments. This is much different than and not as drastic as bankruptcy which is the point at whic you've used up every other option available to you.
Does Credit Counseling Affect My Credit Score?
Credit counseling may not necessarily impact your credit score. But some agencies may report that you are on a debt repayment plan. As such, existing and future creditors can see this information and may decline applications as they may consider you a risk.
What's the Difference Between Credit Counseling and Bankruptcy?
Credit counseling allows you to work with a credit counseling agency to help you pay off your debts by closing your accounts, lowering your interest rates, and in some cases, eliminating additional fees. Credit counseling may not necessarily affect your credit rating or your ability to borrow in the future.
Bankruptcy, on the other hand, is usually a last resort. Borrowers who file for bankruptcy are usually at the end of the line after having exhausted all other avenues. They usually have so much debt that they can't even manage minimum payments. Creditors are usually willing to settle lower amounts versus what's owed and borrowers are usually required to sell certain assets. Declaring bankruptcy does affect your credit report and credit score.
The Bottom Line
If you can't manage your debt but you aren't on the verge of bankruptcy, it may be worthwhile to consider credit counseling. This involves using the services of a professional agency that can step in to help. A credit counselor will help you make and manage a plan that can eliminate your debt. Keep in mind that, although it may not impact your credit score, the agency may report that you are using their services on your credit report. It's always a good idea to check with the agency about whether it reports to the credit bureaus.
