If you find yourself over your head in debt, there is always a light at the end of the tunnel. Credit counseling agencies, both for-profit and non-profit, exist in every state to help people build a clear, workable path back to healthy personal finances.
If you do need the help of a credit councilor, this is what you can expect.
What is Credit Counselling?
Credit Counselling is a service offered to help people bring their personal finances under control. A large part of what they do is purely education, usually with many free resources available. Just like your health, big problems are best addressed with prevention, before the problem gets out of control. If you are reading this, you are already working through some course work that would be similar to what would be offered by a credit counselling agency.
Unfortunately, most people reach out for help only after debts start to spiral out of control. At this point, you will need to meet one-on-one with a credit counselor to chart a path forward and get yourself out of debt.
There are three main tools applied by credit counselling agencies before bankruptcy enters the discussion – Budget Building, Debt Management Planning, and Debt Settlements.
Who are Credit Counselors?
Credit counselling is loosely regulated by FINRA, which sets rules for what can be advertised and advised. Reputable credit counselors have a professional certification, usually from the NFCC, or National Foundation of Credit Counselors.
There are both for-profit and non-profit credit counselors – the NFCC usually works with non-profit institutions. The cost of getting credit counselling will vary from agency to agency, but usually starts as a flat fee for your initial consultation, plus a percentage of the total debt settled if you require more help.
This is the first step of working with a credit counselor. You will usually sit down for a 1-2 hour meeting to discuss your current situation. This includes your total debt load, income, expenses, and how you are currently spending your money.
Your counselor will review all of this with you, and recommend some educational materials or courses with some more advanced techniques for discharging your debt as quickly and cheaply as possible. They will also work with you to build a new budget that you can afford.
How Is This Different from My Own Spending Plan?
If you already have a strong budget or spending plan, and have simply fallen behind on payments because of spending shocks or income loss, this step of the process may not tell you much that you do not already know.
Statistically, most people do not have a budget or spending plan actually laid out that gets updated with any regularity. One of the biggest advantages of speaking to the credit counselor is that they are a completely unbiased 3rd party working to get you out of debt. This helps craft or revise a stronger budget, based on purely the facts and figures, not emotion or panic. Working with a certified credit counselor is also a good way to learn about tax incentives, subsidies, or other debt relief programs in your state that you may otherwise not be aware of.
Debt Management Planning
If your debt problems cannot be addressed by rearranging your budget, the next step is creating a Debt Management Plan.
With a Debt Management Plan, your credit counselor will work directly with most of your creditors (usually everything except Secured Loans, like mortgages and car loans). Your credit counselor will negotiate to get as many late fees and finance charges waived as possible, and set up regular monthly payments to pay off the debt.
Instead of paying your creditors directly, you now make one monthly payment to your credit counselling agency, which then distributes that payment to each creditor (according to the terms they could negotiate).
Debt Management Plan and Debt Consolidation
Debt Management Planning is superficially like debt consolidation, where you take out one big loan to pay off many smaller debts. Debt consolidation is often also part of the credit counselling process, and your credit counselor will be able to help decide if it should be part of your payment plan.
When you work with a credit counselor, their goals are to help you repay your debt as fast and cheaply as possible. They usually discourage taking out more loans, unless it is the only option available to preserve your credit rating.
Advantages of Debt Management Plans
In theory, your debt management plan will not be very different from something you could build yourself, if you are able to successfully negotiate with your creditors. However, it does have some distinct advantages:
- Experienced Negotiators. Your credit counselor is a professional credit negotiator, and so they know the right buttons to push to get your fees lowered as much as possible.
- Relationship with Creditors. Your credit counselors already have established channels of communication with most creditors, so they know exactly who to talk to in order to get things moving smoothly. This can even include things like moving around payment due dates to get everything all on one schedule.
- Leverage with Negotiations. When your credit counselor is in contact with your creditors, your creditors know that you are in a tight spot financially (and not making up some story over the phone). Your creditors are not interested in driving you into bankruptcy, since that means they do not get paid. This usually makes them more flexible when negotiating with credit counselors compared to when you speak with them directly.
- Clear Reporting. Your credit counselor will send you monthly reports about the exact status of all your debts, including how quickly each is being paid off.
- Lower Total Payments. When we outlined juggling bills, we saw that it can be cheaper to pay off some bills completely than make minimum payments on everything. Your credit counselor knows this too, and will optimize the payment schedules to pay off the most expensive debts the fastest, and minimize the total amount you need to pay.
Restrictions of Debt Management Plans
Debt Management Plans are not always a simple solution, and can require some tight restrictions on what you can and cannot do.
- No New Credit. When you enter a Debt Management Plan, it appears on your credit report (not as a positive or negative, just that it exists). This serves as a warning to any other creditors that you should not be extended any new credit. If you do get a new line of credit anyway, your credit counselor will terminate your Debt Management Plan, putting you back at square one.
- Cancel All Credit Cards. Most household debt that requires credit counselling comes from credit cards. Debt Management Plans require you cancel all open credit cards, and you cannot open new ones until your current debt is paid off (not including mortgages).
- Tricky Relationship with Creditors. Just because you are using a debt management service does not mean your creditors will stop calling. Once you are on a plan, most credit counselors will advise you to cease all communication with your creditors, and let them handle it. If you do speak with your creditors and say something that conflicts with the negotiations your counselor has been working on, it could sink your whole plan.
If your debts are too great compared to your income to reasonably pay off with a Debt Management Plan, the next step is Debt Settlement. With Debt Settlement, your credit counselor will set up the same type of monthly payments you need to make, but they deposit the money into a separate savings account, and do not pay any of your creditors.
Instead, they enter “hardball” negotiations – their position now is that you are on the verge of bankruptcy, and your creditors can reduce the total amount owed to something you can afford, or risk not getting paid at all if you go bankrupt. Once your creditor and your counselor come to an agreement on that new lower amount, your creditor gets paid off out of that savings account you have been paying in to.
Advantages of Debt Settlement
Debt Settlement is the “Nuclear Option” when it comes to paying off your debts. The only step farther is declaring bankruptcy.
The major advantage Debt Settlement has over a regular debt management plan is that the total amount you must pay will be significantly reduced. This includes reducing or eliminating the finance charges, plus it can reduce the principle (no other non-bankruptcy solution will reduce your principle owed). That this point, your creditors are trying to take whatever they can get, hoping to not be left with nothing if you go bankrupt.
Disadvantages of Debt Settlement
Every other debt management solution works to preserve your credit rating, and keep all your creditors happy and your budget secure. Debt Settlement does not. This adds some unique disadvantages, which should leave debt settlement as an option of last resort.
- Immediate Damage to Your Credit. With debt settlement, you immediately stop paying all creditors while the negotiations are in progress. This means your creditors will immediately start reporting you as delinquent on all of your accounts, which will do a lot of damage to your credit.
- Long-Term Damage to Your Credit. There are three statuses your credit report shows for every account: “OK/Paid”, “Late/Delinquent”, and “Settled”. A “Settled” status means it was discharged through a debt settlement negotiation. This is better than an unpaid account, but it is nowhere near as good as “OK/Paid”. This will remain on your credit report for at least 7 years.
- Increased Harassment. Your creditors will not be happy when you stop making monthly payments, and will try to bounce claims off you and your credit counselor at the same time, trying to “catch” inconsistencies to improve their bargaining position. Your credit counselor will usually advise to not answer your creditors at all while debt settlement negotiations are in progress.
- Credit Restrictions of Debt Management. You will still be required to close your credit cards and be prevented from opening new lines of credit while the negotiations are in progress.
Predatory Credit Counselling Services
If you enter Debt Settlement Proceedings, your credit counselor will usually take a fee as a percentage of the total amount of debt that they are able to get “cancelled”. For example, if they negotiate a $1000 debt down to $700, they may charge you $150 as a fee for the service.
For large debt loads, this can be a real money-maker, which opens the door to predatory practices. A predatory credit counselor will usually advise Debt Settlement as a first step, or suggest it before exploring other alternatives. There are plenty of cases where debt settlement is the best option, but if it is the first suggestion, you may want to get a second opinion.