What is Credit Counseling and How Does It Work?

Do you feel crushed by your debts and do not know how to get a handle on your finances, despite the advice you have read so far in this chapter and in the book? Have you unsuccessfully tried the self-help options we discuss elsewhere? Take heart: there is a calm harbor in the storm: the debt counseling agency. Among other things, the agency can help you create a budget and find a way to deal with your debt.

The benefits of debt counseling require that you work with a reputable, nonprofit debt counseling agency that employs trained and certified debt counselors and that charges fair rates for its services. 

Many credit counseling agencies talk about a good game and have impressive websites, but they charge a lot of money for their services and provide little in return. If you work with one of these agencies, your finances could get worse instead of better. Yikes!

If you are interested in credit counseling, read on. Here, we give you the information you need to find a reputable organization. We explain how good credit counseling companies work. And we give you a series of questions to ask before you commit to working with an organization. We also tell you about debt management plans in case a debt counseling agency suggests one to you, and we tell you how to get the most benefit from such a plan.

We will also educate you about the dangers of working with a debt settlement company – a company that agrees to settle your debts for less than the amount you owe them. Some consumers confuse debt settlement with debt counseling; we explain what the difference is between the two. And finally, we tell you what to do if you get ripped off by a debt counseling agency or debt settlement company.

What Does Credit Counseling Agency Do?

A reputable credit counseling agency evaluates your finances and comes up with a plan for helping you get out of debt and avoid financial problems in the future. Among other things, the agency

Reviews your budget to make sure it is realistic and suggests improvements and/or additional cuts. If you do not already have a budget, the agency helps you develop one.

Assesses the state of your finances. After reviewing your financial information, the agency gives you a realistic picture of where you are right now financially: no better or worse off than a lot of consumers, on the brink of bankruptcy, or somewhere in between.

Figures out how you can keep up with your debts. The agency may revise your budget in order to generate more cash flow (the amount of money you have to spend) each month so you can pay your debts off faster. Or it may recommend that you participate in a debt management plan in order to lower your monthly debt payments to amounts you can afford. 

If your finances are in really bad shape, the agency may suggest that you meet with a consumer bankruptcy attorney. If the credit counseling agency advises you to pay off your debts through a debt management plan, the agency will explain how the plan works and review its pluses and minuses. 

Also, the agency should give you a general idea of how much you’ll have to pay on your debts each month if it sets up a debt-management plan for you. When a credit counseling agency sets up a debt-management plan for you, the plan will address your unsecured debts, like credit card debts, unpaid medical bills, and student loans. Most credit counseling agencies will not help you with your secured debts, such as your mortgage, home equity loan, and car loan.

Helps you set financial goals and provides you with financial education. The financial education may include workshops and seminars on various aspects of money management, as well as brochures and workbooks.

How To Find A Reputable Credit Counseling Agency?

Below are some tips to help you find a reputable credit counseling agency that can help with your finances.

1. Telling the good from the bad

Most credit counseling agencies are truly interested in helping consumers get a handle on their debts and develop a solid foundation for a financially sound future. However, some agencies are mostly out to make a buck (or lots of bucks) off consumers who are desperate for help and unaware of the differences between reputable and disreputable credit counseling agencies. 

Sadly, consumers who work with a bad apple agency are apt to pay it a lot of money — money they could have used to pay their debts or their living expenses — and get little or nothing in return. In fact, many of these consumers end up worse off financially than they were before. 

For example, bad-apple credit counseling agencies may charge excessive fees, push consumers into debt-management plans when they don’t need them (so the agencies can charge plan administration fees each month) and offer no financial education or goal-setting assistance. That’s the bad news. 

The good news is that it’s relatively easy to find a good credit counseling agency, assuming that you know the questions to ask and the telltale signs that an agency may not be on the up and up. If an agency’s promises about what it can do for you sound too good to be true, they probably are. Watch out! 

No matter how much you may want to believe what it says, look for another credit counseling agency to work with. Avoid credit counseling agencies that solicit your business by phone or email. Also, don’t be impressed by agencies that spend money on glossy print ads and regular ads on TV or radio. Reputable organizations do not spend a lot of money on advertising and rely mostly on referrals and word of mouth.

2. Locating agencies in your area

When you look for a credit counseling agency to work with, check out a couple so you can feel confident that you are going to get good help. Ask friends or relatives who have had a good past experience with credit counseling for a referral. Don’t know anyone who’s worked with this kind of agency? Here are two other excellent resources for finding a good one:

The counselors who work for credit counseling agencies that are affiliated with these two organizations are trained and certified.

Another excellent source of reputable credit counseling agencies is the Web site of the United States Trustee. These days, people who want to file for bankruptcy have to obtain a certificate to file from a credit counseling agency. Only credit counseling agencies that have been certified by the federal Trustee’s office can issue this type of certificate. We think it’s safe to assume that the certified agencies are reputable. 

To find a certified credit counseling agency in your state, go to https://www.justice.gov/ust and click on “Credit Counseling & Debtor Education.” If you don’t find credit counseling agencies in your area, or if you would have a difficult time going to a credit counseling agency’s office during business hours, many good agencies offer online counseling that can be just as effective as meeting face to face with a credit counselor. However, if you choose to get the counseling, your method of selecting a credit counselor and your expectations should be the same.

3. Knowing what to ask and what to expect

After you have the names of some agencies, ask each the following set of questions by meeting with a representative from each agency, emailing them from their Web sites, or talking with them on the phone. Do not pay a credit counseling agency any money or sign any paperwork until you have received satisfactory answers to each of these questions:

Are you a federally approved, nonprofit, tax-exempt credit counseling agency? Nonprofit agencies will charge you the least for their services and provide you with the most in return. Some credit counseling organizations are for-profit businesses even though their names make them sound like they are nonprofits.

Get proof that a credit counseling agency is truly a nonprofit by asking for a copy of its IRS approval of nonprofit status letter. The letter is a one-page document. Don’t work with an agency that refuses to let you look at this letter or never provides it.

Do you have a license to offer credit counseling services in my state? Although some states do not license credit counseling organizations, many do. You can find out if your state requires licensing by contacting your state attorney general’s office. If your state does issue licenses, ask for the name of the licensing agency and then get in touch with it to confirm that the credit counseling agency has a valid license.

What services do you offer? The upcoming section “Working with a Credit Counselor” describes the services the agency should offer.

How do you charge for your services? Reputable credit counseling agencies charge little or nothing for most of their services. However, if you participate in a debt management plan, you will be charged a small monthly administrative fee — probably $40 per month tops. Less- reputable agencies charge substantial upfront fees — as much as several hundred dollars — as well as steep monthly fees if they put you in a debt management plan.

Some credit counseling agencies that are not on the up and up don’t charge large fees but charge a lot of small fees instead. Over time, all those small fees really add up. Ask the credit counseling agency for a comprehensive list of fees. If it refuses to provide a list or tells you it does not have one, steer clear! 

Some states regulate the amount of money a credit counseling agency can charge to set up a debt-management plan and to administer it. Contact your state attorney general’s office to find out if it regulates these fees. 

Watch out for credit counseling agencies that encourage you to give them voluntary contributions. The contributions are nothing more than fees to make the agencies more money at your expense.

Will I be assigned a specific credit counselor to work with? You should expect to work with one credit counselor.

How do you pay your credit counselors? Reputable agencies pay their counselors a salary or pay them by the hour. Avoid agencies where credit counselors make money by selling services to consumers. The counselors are nothing more than commissioned salespeople who have a financial incentive to get you to buy as many services as possible whether you need them or not.

Can I see a copy of the contract I must sign if I work with you? Don’t work with an agency that does not use a contractor that won’t share a copy with you. The contract should clearly state exactly what services the agency will be provided to you, a timeline for those services, and any fees or expenses you must pay. It should also provide information about any guarantees the credit counseling agency is making to you, as well as the name of the credit counselor you’ll be working with and the counselor’s contact information.

How will you keep my personal and financial information private and secure? With identity theft on the rise, you must feel confident that the agency has a strong policy in place to protect your information from strangers.

After you find an agency you’d like to work with, check it out with your local Better Business Bureau and with your state attorney general’s office. If either organization indicates that numerous consumers have filed complaints against the agency, reconsider your decision.

You should also check with the Federal Trade Commission (FTC). The FTC is aggressively cracking down on businesses that pretend to be nonprofit credit counseling agencies.

How To Work With A Credit Counselor

After you have chosen a credit counseling agency, your assigned credit counselor will spend time becoming familiar with you and your finances. If you meet face to face with the counselor, you should expect your initial meeting to last about an hour, and you should expect to have a couple of follow-up meetings. If you get your counseling online, you will exchange information and get your questions answered via email.

1. Sharing your financial situation

At your first meeting (or soon after), be prepared to provide your counselor with such information as

  • Your household budget, if you have one.
  • A list of your debts, including whether they are secured or unsecured.
  • The amount of money due on each debt every month.
  • The interest rate for each debt.
  • Which debts you are behind on.
  • The assets you own and their approximate market values (meaning how much you could sell them for).
  • Copies of your most recent tax returns or pay stubs reflecting your monthly take-home pay.

The counselor uses all this information to prepare a get-out-of-debt plan customized just for you. Not only will the plan provide you with a road map for getting out of debt; it should also help you work toward your financial goals like buying a home, saving for your retirement, helping your children pay for their college educations, and so on. 

As part of your plan, the credit counselor may suggest that you enroll in one or more of the agency’s money-management seminars and workshops so you can gain the information and tools you need to avoid debt problems in the future and achieve your financial goals. 

The seminars and workshops may focus on topics like smart budgeting, managing debt, financial goal-setting, and so on. Also, the counselor may give you free money-management materials to read.

2. Whittling down your debt with a debt management plan

If your counselor is unable to figure out a way for you to pay off your debts by reducing your expenses and maybe making more money, the counselor may recommend that you participate in a debt management plan. When you participate in such a plan, the counselor tries to negotiate smaller monthly payments with your creditors.

Getting creditors to buy in

The counselor determines exactly how much you can afford to pay to your unsecured creditors each month in order to eliminate each debt over a three- to five-year period. Then the counselor contacts the creditors to find out if they will agree to let you pay the amounts you can afford. In some instances, the counselor may also ask the creditors for other concessions, such as lowering your interest rates and reducing or waiving any fees you may owe to them. 

If your unsecured creditors believe that giving you what you need is their best shot at getting the money you owe, and if they believe you are likely to file for bankruptcy otherwise (which means they may not get a penny from you), they will probably agree to the plan the credit counselor has proposed. 

However, most large creditors will have a minimum amount that they expect you to pay on your debts each month; unless you commit to paying it, they won’t agree to participate in your plan. If some of your creditors refuse to work with you, you have to continue paying them according to the original agreements with them. 

Many creditors are willing to offer special concessions to consumers who pay off their debts through a debt management plan. In return, they expect that consumers will not incur additional debt while they are in their plans.

Working the plan

After the credit counselor has prepared your final debt-management plan, ask for a copy. Do not sign it until you have read it carefully, understand everything in it, and are sure that you can live up to it. Note any restrictions in the plan. 

For example, it may prohibit you from taking on additional credit with your current creditors or applying for new credit while it is in effect. If you violate any aspect of your plan, you risk having it cancelled. When your plan is official, you pay your credit counselor every month the amount of money you have agreed to pay on your debts, as well as the required monthly fee. 

In turn, the counselor pays your creditors. Make sure your debt-management plan says that your credit counselor will send you regular monthly updates on the status of your debt management plan, including confirmation that each of your creditors was paid according to the terms of the plan.

Beware of credit counseling agencies that spend little or no time evaluating your finances before advising you to enroll in a debt management plan or that ask you to begin paying on a debt management plan before your creditors have agreed to work with you. 

Also, be aware that some creditors who agree to be part of your plan may report you as slow-paying or as paying through a debt management plan, which will damage your credit history a little. However, statistics show that successfully completing a debt-management plan actually increases your FICO score — the numeric representation of your creditworthiness that is derived from the information in your credit history.

Actively managing your plan

Even when you are careful about choosing a credit counseling agency to work with, if you participate in a debt management plan, problems can develop that may undermine the plan’s benefits. Follow these tips to minimize the potential for problems:

  • After your counselor tells you which of your unsecured creditors have agreed to participate in your debt management plan, contact them to confirm their participation before you send the counselor any money. However, taking this step before paying any money may not always be possible. Due to cost constraints, a nonprofit credit counseling agency may not contact your creditors to find out if they will participate in your debt-management plan until you have given the agency an initial month’s payment on the plan. The agency wants to be sure that you are serious about paying your debts before it spends time negotiating the plan details with your creditors.
  • If your counselor tells you that one of your creditors won’t agree to participate in your plan until you send the counselor an upfront payment, contact the creditor to confirm that what the counselor says is true.
  • Make sure that the schedule your counselor sets up for paying your debts provides enough time for your creditors to receive what they are owed each month before the payment due dates. Otherwise, you risk racking up late fees and penalties.
  • Every month, just after the date that your counselor is due to make a payment, confirm with the counselor that the payment was made on time.
  • Whenever you receive a monthly statement of your account from one of the creditors participating in your debt management plan, review it carefully to make sure your account was credited appropriately. Also, make sure that each creditor made whatever concessions it agreed to make, such as lowering your interest rate, waiving certain fees, or allowing you to make reduced payments or interest-only payments for a while.

Avoiding Debt Settlement Firms

Some people confuse debt settlement firms, also known as debt negotiation firms, with credit counseling agencies. Don’t make this mistake. Although a debt settlement firm may try to confuse you by choosing a name that sounds like a nonprofit credit counseling agency, debt settlement companies are in business to make money. The services they offer are very different from those of a legitimate credit counseling agency. Also, if you work with a debt settlement firm, you risk harming your finances and damaging your credit history and your FICO score.

Being wary of false promises

Debt settlement firms claim that they can settle your unsecured debts for less than the full amount you owe on them. In other words, after you pay the settlement amounts, your creditors will consider the debts to be paid in full. 

For example, if you owe $10,000 in credit card debt, a debt settlement firm may tell you that it can get the creditor to agree to let you pay the debt off for $6,000. You can try to settle your own debts, for free. You don’t need a debt settlement firm to do it for you. (But keep in mind that if a creditor agrees to forgive part of your debt, the IRS will probably treat that forgiven amount as income to you, and you will be taxed on it.) 

If you receive an IRS 1099 form related to a debt that you settled, talk to a CPA. If the CPA can prove that you were insolvent at the time that the amount of the debt was forgiven, you won’t be taxed on that amount. You’re insolvent if you don’t have enough money to pay your debts and living expenses and you don’t have any assets you can sell to pay off the debts.) 

Some debt settlement firms also promise that after they settle your debts, they can get all the negative information related to those debts removed from your credit history. Not true! Only the creditors that reported the negative information can remove it. If you agree to work with a debt settlement firm, you may be told to stop paying your unsecured creditors and to begin sending that money to the firm itself. 

The problem is that a debt settlement firm may be all talk and no action. It may not be able to settle your debts for less. In fact, it may not even try. Furthermore, if it does intend to try to settle your debts, it may take months for the firm to accumulate enough money from the payments you are sending to be able to propose settlements to your creditors. 

Meanwhile, your debts are going unpaid, your credit history is being damaged further, and the total amount you owe to your creditors is increasing because late fees and interest are accumulating.

If you question a debt settlement firm about the consequences of not paying your debts, you may hear that your unsecured creditors won’t sue you for their money. That is flat-out wrong.

Preventing worse financial problems

Debt settlement firms charge much more money than legitimate credit counseling agencies. If you work with a debt settlement firm, you may have to pay one or more substantial upfront fees, as well as additional fees that may be based on the number of unsecured credit accounts you have, the amount of debt you owe, or the amount of debt that the firm gets your creditors to forgive. In the end, the cost of working with a debt management firm may be more than the amount of money you save from settling your debts. 

Be careful if a debt settlement firm offers to loan you money, maybe more than you can really afford to pay. Not only is the loan likely to have a very high-interest rate and other unattractive terms of credit, but if you are not careful, you may sign paperwork giving the firm the right to put a lien on an asset you own. The firm is hoping that you’ll fall behind on your loan payments so it can take the asset from you.

What To Do If You Fall Victim To Credit Counseling Scams?

If you get taken by a disreputable credit counseling organization or by a debt settlement firm, contact a consumer law attorney right away. The attorney will advise you of your rights. He may recommend sending a letter on his law firm stationery to the credit counseling organization or debt settlement firm threatening legal action unless the firm makes amends to you (such as by giving you your money back). 

The credit counseling organization or debt settlement firm may agree to the attorney’s demands in order to avoid a lawsuit. If it does not respond or refuses to do what the letter asks, you can decide if you want to go forward with a lawsuit.

Assuming that you have a strong case, the attorney will probably represent you on a contingent fee basis. This means that you won’t have to pay the attorney any money to represent you. Instead, the attorney gambles that you will win your lawsuit, and the attorney will take his fee from the money that the court awards you as a result. 

If you lose your lawsuit, you do not have to pay the attorney a fee. However, depending on your agreement with one another, win or lose, you may have to pay the attorney’s court costs and any other fees and expenses related to your case.

Regardless of whether you sue the credit counseling organization or debt settlement firm, you should file a complaint against it with your state attorney general’s office, your local Better Business Bureau, and the Federal Trade Commission (FTC). Although none of these organizations can help you get your money back or undo any damage done to your credit history and your FICO score, other consumers who may be thinking about working with the same credit counseling agency or debt settlement firm may think twice after reading your complaint. 

Also, if your state attorney general’s office or the FTC receives a lot of complaints about the credit counseling agency or debt settlement firm, it may take legal action against it. For example, it may file a class-action lawsuit on behalf of everyone who was ripped off.

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