About Credit Counseling

Function

TV Ads Poking Fun at Debtors' Plights Often Inspire a Sharp Backlash.

Credit counseling agencies essentially offer three services, starting with debt management programs to help people get their finances in order. Once a consumer enrolls, the agency negotiates with creditors to consolidate multiple monthly payments into a single lower rate---typically touted at 50 percent of the total amount owed, but more commonly ending up at 10 to 20 percent. This step triggers the second service---a dramatic reduction in interest rates. If creditors agree to these reductions, consumers can cut the typical 20- to 30-year repayment period to a third of that figure. Finally, credit counselors can also help bring delinquent accounts up to date as a show of good faith. This step does not remove older negative information on a person's credit report, but at least offers the debtor a chance to rebuild a positive credit history.

Credit counseling has a well-established history in America. Formed in 1951, the National Foundation for Credit Counseling (NFCC) is the oldest organization, essentially serving as a voice of the industry in promoting financial literacy and sound money management. However, the American Association of Debt Management Organizations is considered the largest, most visible group. Local equivalents began to appear during the 1960s and gained momentum during the early 1980s, when a recessionary economy led to a major credit shrinkage. However, not all of the roughly 1,000 counseling agencies belong to any kind of trade association, nor are they legally required to do so.

Renewed media attention focused on credit counseling in 2005, when Congress passed the Bankruptcy Abuse Prevention and Consumer Protection Act. The most significant provisions drastically curtailed the numbers of debtors who could file a Chapter 7 bankruptcy, the most common debt-relief action sought by consumers, and force them into a Chapter 13 filing---which requires a repayment plan. To meet this standard, debtors must finish a program with an approved nonprofit counseling agency in the 180-day period preceding a bankruptcy filing. A postcounseling session is also required. The law's congressional sponsors argued that these steps were necessary to clamp down on abuses, while critics saw the measure as a billion-dollar gift to the credit card companies---and counseling agencies---that appeared to benefit from millions of new repayment plan filings.

Controversy has dogged credit counseling for various reasons. Since counseling agencies are compensated from repayments---a system known as "Fair Share"---critics brand the agencies as nothing but another type of collection agency. Other complaints filed with the Federal Trade Commission focus on overly high or hidden fees. Some companies earned criticism for swallowing the first month of repayment fees, instead of sending them to creditors---such as the notorious AmeriDebt, whose founders eventually sought Chapter 11 bankruptcy protection in 2007. Training standards have also come under fire. In many instances, the counselors may only have been minimally educated to promote their company's products, instead of instructing consumers on financial management techniques.

Perhaps the most damaging allegations raised against credit counseling agencies is that participating in their programs may actually ruin a consumer's credit rating. This claim is dismissed by the Fair Isaac Corporation, the company that pioneered the numerical scores used to assess general creditworthiness. The U.S. Housing and Urban Development Agency and Fair Housing Administration also take a neutral attitude, stating their only concern is whether an applicant is living up to the credit program's requirements. Consumers are advised to research a lender's attitudes toward debt management programs, which may have implications on higher-level debts like car or home loans. In those cases, lenders may see a debt management program as proof that an applicant does not manage one's money properly, and thus reject the loan. For their part, credit counselors argue that their job is merely to work out settlements, not take sides in debtor-creditor disputes.