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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 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 committment 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.
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.
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.
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