The simplest way to think about debt counseling services is to think of them as therapists for your finances. First a debt counseling service is chosen and an appointment made. The client or customer then sits down with the therapist (counselor) who will discuss his or her finances, including income expenses and budget – if the person has one.
Next, the counselor will help the client develop a plan called a DMP or debt management plan for getting his or her finances under control and paying off the creditors. The counselor will contact all of the client’s creditors and present the DMP to them for approval. If they all approve it, the client will no longer be required to pay them. Instead, he or she will send one payment a month to the debt counseling service, which will then pay the creditors.
The pros of debt counseling
For many people, the biggest pro of debt counseling is that it’s a way to consolidate debts without having to borrow more money.
Suppose, for example, that a person owes a total of $18,000 to five different creditors at an average interest rate of 19%. A debt counseling service could work with those creditors to have that average interest rate reduced to, say, 12%. The client would have a single monthly payment of around $400 vs. the $650 or so that he or she had been paying.
Debt counseling services won’t have a negative impact on credit reports or credit scores as would a bankruptcy. In fact, credit counseling should have absolutely no effect on one’s credit score.
Once a person is enrolled in a credit counseling service, all calls from creditors or debt collection agencies should stop. Late fees and over-the-limit fees should also be waived.
And finally, people who are on a DMP must live within their means and follow a fairly stringent monthly budget, which could be a good discipline.
The cons of credit counseling
As noted above, one of the pros and cons of credit counseling is that those who enroll will be required to follow a very strict monthly budget. This can be very difficult for people who were unable to manage their finances in the first place. Credit counseling participants are required to give up all credit cards and are strongly encouraged to not sign upfor new revolving debt until they finish their DMP’s, which may be as long as five years.
Creditors can report to the credit bureaus that accounts have not been paid as agreed upon, which could hurt the person’s credit score. Being on a debt management plan can make it more difficult to get new credit. And, worse yet, if a person misses just one payment, his or her program might be canceled, creating more of a problem then before the DMP.
Watch out for disreputable credit counseling agencies
Persons interested in credit counseling should make sure they choose a reputable one. There are companies – especially those to be found online – that are very close to scam artists. These agencies tend to charge high upfront fees, promise to pay the person’s creditors but then fail to do so.
The reputable ones
The best credit counseling agencies are nonprofits either charge nothing or very low fees for their services. They are able to do that because financial institutions such as the credit card companies, banks and credit unions underwrite their costs. Two of the best of these are the National Foundation for Credit Counseling (NFCC) and Consumer Credit Counseling Services. Also, the Department of Justice has a website that lists by state the credit counseling agencies it has approved.