Credit counseling

From Wikipedia, the free encyclopedia

Credit counseling (known in the United Kingdom as debt counselling) 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.

Contents 1 Common features of Debt Management Programs 2 History of credit counseling 3 Criticism of credit counseling 4 External links

[edit] Common features of Debt Management Programs

After joining a DMP, the creditors will close the customer's accounts and restrict the accounts to future charges. The most comment 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 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 "reaging" 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 reage 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. It should be noted that 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 being 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.

[edit] History of credit counseling

The first credit counseling agencies were created in 1951 in the United States when credit grantors created The National Foundation for Credit Counseling, or NFCC. Their stated objective was to promote financial literacy and help consumers avoid bankruptcy.

In 1993, the “Association of Independent Consumer Credit Counseling Agencies,” or AICCCA, was founded, citing a need for “industry-wide standards of excellence and ethical conduct.” This formally organized the NFCC’s competition. The AICCCA was formed from the group of counselors who favored telephone delivery of debt management programs. The NFCC was, in the beginning, strongly opposed to this telephone business model, primarily favoring face-to-face counseling as a more effective solution. Eventually, all organizations practiced both phone and face-to-face processes with some agencies using large inbound call centers driven by mass media advertising.

The credit counseling industry’s third major trade organization is its largest: the American Association of Debt Management Organizations, or AADMO.

However, not all credit counseling agencies belong to a trade organization, nor are they required to do so; there are well over 1,000 active credit counseling organizations in the United States.

In 2005, the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 made credit counseling a requirement for consumer debtors filing for Bankruptcy in the United States. In order to meet this requirement, during the 180-day period preceding the filing of bankruptcy, the debtor must complete a program with an approved nonprofit budget and credit counseling agency. Such a program may include, but is not limited to, one counseling session conducted by phone or over the internet. In addition, a post-filing debtor education credit counseling session is required in order to complete the bankruptcy process and to have your debts discharged.

Credit Counselling is also a growing industry in Europe, both for profit-making debt management companies and charities such as Christians Against Poverty and the Consumer Credit Counselling Service, Britain's largest debt advice charity.

[edit] Criticism of credit counseling

In the late 1980s and early 1990s, the number of credit and debt counseling agencies in America increased significantly. An antitrust lawsuit was filed against the NFCC, arguing that the presence of creditors on the NFCC’s Board of Directors constituted monopolistic practices. As a result of this litigation, creditors agreed to fund non-NFCC member agencies as well.

These sharp increases of credit counseling activity also created other, more serious issues in the industry. By the early 1990s, abuses by certain credit counseling organizations were so significant, it led to criticism of the entire industry.

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 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.

The lobby against credit counselors arises from the belief by the collection industry that the not-for-profit status of the credit counselors gives them an unfair financial and market advantage over them. The IRS apparently agrees. The tax exempt revocations seem to be centered around whether a tax exempt credit counselor actually performed their mandated mission by assisting the community at large, other than their whole attention to their own DMP customers in a "collection practice" (no one knows for sure however).

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 does appear on consumer credit reports, and the client may have more difficulty securing a car or home loan and be denied any further unsecured credit, such as a credit card. Some lenders view a prospective customer's participation in a Debt Management Plan as indicative of the customer being unfit to manage their finances.

Counseling agencies have also been criticized for understating their clients' future responsibilities during the initial enrollment process. Agencies have been accused of telling clients to stop paying creditors directly and cease all telephone contact with creditors. This can result in accounts falling past due during the period that the client transitions into the DMP. Many clients come to the DMP with current accounts; they are simply seeking lower interest rates rather needing help bringing their accounts current. It takes the average DMP 1-2 months to start making disbursements to creditors, during which time the accounts will fall past due if the client does not continue making direct payments to the creditors. Often this is impossible, however, because the client cannot afford to pay the DMP an advance payment as well as pay the creditors the normal monthly payment amounts. In this way a client's credit can be damaged as the accounts unintentionally fall past due.

Given this criticism, the industry is likely to be changed forever in the immediate future as it is scrutinized by both the consumer and government regulators over how they will be paid for the services they perform. In meantime, there will be no shortage of debt-burdened consumers who will now be facing a burgeoning, and more traditional, collection industry.

It should also be noted that many credit counseling services employ people hired off the street who are then trained in credit counseling. Thus the person helping you may not have any formal training in financial management other than what they received when they got hired as a credit counselor. This training is usually minimal and focused only on the services provided rather than a full course on financial management.

[edit] External links

• Pension Protection Act of 2006 as it pertains to credit counseling agencies
• American Association of Debt Management Organizations
• Association of Independent Consumer Credit Counseling Agencies
• Bankruptcy Abuse Prevention and Consumer Protection Act of 2005, Section 106
• FTC Consumer Alert: New Bankruptcy Law Requires Credit Counseling Before Filing
• FTC explains New Bankruptcy Law Requires Credit Counseling Before Filing
• FTC New Bankruptcy Law Requires Credit Counseling
• FTC Testifies about Credit Counseling Abuses
• Fiscal Fitness: Choosing a Credit Counselor
• FTC, IRS, and State Regulators Urge Care When Seeking Help from Credit Counseling Organizations
• (pdf) The Impact of Credit Counseling on Subsequent Borrower Credit Usage and Payment Behavior
• IRS Revoking Exemptions Of Credit Counselors
• National Foundation for Credit Counseling
• US Trustees list of approved credit counselers for Bankruptcy
• US Trustees list of approved providers of Personal Financial Management Instructional Courses (Bankruptcy Education)