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Credit Counseling
Credit counseling is a process offering education to consumers about how to
avoid incurring debts that cannot be repaid. This process is actually more debt
counseling than a function of credit education.
Credit counseling often involves negotiating with creditors to establish a debt
management plan (DMP) for a consumer. A DMP may help the debtor repay his or her
debt by working out 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.
After joining a DMP, the creditors will close the customer's accounts and
restrict the accounts to future charges. The most common benefit of a DMP as
advertised by most agencies is the consolidation of multiple monthly payments
into one monthly payment, which is usually less than the sum of the individual
payments previously paid by the customer. This is because credit cards banks
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.
The second feature of a DMP is a reduction in interest rates charged by
creditors. A customer with a defaulted credit card account will often be paying
an interest rate approaching 30%. Upon joining a DMP, credit card banks
sometimes lower the annual percentage rates charged to 5-10%, and a few
eliminate interest altogether. This reduction in interest allows the counseling
agencies to advertise that their customers will be debt free in periods of 3-6
years, rather than the 20+ years, assuming only minimum payments were being
made, that it would take to pay off a large amount of debt at high interest
rates.
A third benefit offered by credit counseling agencies is the process of bringing
delinquent accounts current. This is often called "re-aging" or "curing" an
account. This usually occurs after making a series of on-time payments through
the debt management program as a show of good faith and commitment to completion
of the program. For example, a client with an account with 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 joining the DMP and making three consecutive monthly
payments, the creditor could re-age the account to reflect a current status.
Thereafter the monthly payment due on the statements would be the monthly
payment negotiated by the DMP, and the account report as current to the credit
bureaus.
This process does not eliminate the prior delinquencies from the credit
bureau reports. It merely gives a fresh start and an opportunity for the client
to begin building a positive credit history. Like all derogatory credit
information, the passage of time will lessen the impact of the negative marks
when credit scores are calculated.
A credit counseling agency typically receives most of its compensation from the
creditors to whom the debt payments are distributed. This funding relationship
has led many to believe that credit counseling agencies are merely a collections
wing of the creditors. This fee income, known as “Fair Share,” are contributions
from the creditors that originally earned the agency 15% of the amount
recovered. However, in recent years, Fair Share contributions have dwindled
steadily, with contributions of 4-10% being the most common.
Still, the National Foundation of Credit Counselors (NFCC) considers bankcard
companies to be one of their primary "constituents," and the
NFCC website
promotes the fact that they collect $5 billion for creditors each year. It also
promotes their efforts to steer consumers away from bankruptcy.
The Federal Trade Commission has filed lawsuits against several credit
counseling agencies, and continues to urge caution in choosing a credit
counseling agency. 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. The Better Business
Bureau also reports high complaint levels about credit counseling.
The IRS also has weighed in on the subject of credit counseling, and has denied
nonprofit 501(c)(3) tax-exempt status to around 30 of the nation's 1000 credit
counseling agencies. Those 30 credit counseling agencies account for more than
half of the industry's revenue. Audits of non-profit credit counseling agencies
by the IRS are ongoing.
Congress has also investigated the credit counseling industry, and issued a
report that said while some agencies are ethical, others charge excessive fees
and provide poor service to consumers. The report also stated that NFCC member
guidelines, if applied to the entire credit counseling industry, would go a long
way toward eliminating the abuses they uncovered in some parts of the industry.
Other organizations have voiced criticisms of the credit counseling industry,
often citing the Fair Share funding model as evidence that credit counselors
serve the interests of the creditors over the interests of consumers, and that
credit counselors are not forthcoming in speaking out about the actions of
creditors for fear of losing what little funding remains. Credit counselors
respond that their job is not to take sides but to negotiate with all parties
equally to help successfully resolve debts. They further argue that the steady
decline in Fair Share funding belies the notion that creditors are in control of
the credit counseling industry.
Another common criticism of credit counseling is the assertion that
participating in a Debt Management Plan will ruin a consumer’s credit. Fair
Isaac Corporation, the company that pioneered the use of credit scores, states
that participation in a Debt Management Plan has no effect on a consumer's FICO
credit score. However, the participation in such a plan may appear on consumer
credit reports, and the client may have more difficulty obtaining a car or home
loan and be denied any further unsecured credit, such as a credit card. This is
because lenders often use multiple risk factors to determine creditworthiness.
The major factor holding consumers back is the amount of debt they have relative
to their income (the debt to income ratio) and not enrollment in a credit
counseling plan. While credit card banks offering relatively low-credit-line
cards may use a credit score alone to approve a new account, a mortgage or car
lender typically will scrutinize the entire credit report more extensively and
verify employment and income information. Some lenders view a prospective
customer's participation in a Debt Management Plan as indicative of the customer
being unfit to manage their finances. |
