Whats Wrong with Credit Counseling?
by Charles J. Phelan
Published on this site: April 14th, 2005 - See
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Cut Your Payments in Half! the headline screams. Consolidate
Your Bills into One Low Monthly Payment!
When you see ads like this, they are often from Credit Counseling
firms. In this article, Ill explain the principles behind
the Credit Counseling approach and discuss the main problem consumers
face when they join one of these programs.
First, lets get our definitions straight. The term Credit
Counseling is actually quite misleading, since it has nothing
to do with preserving or improving your credit score. In fact, Credit
Counseling will often damage your credit, an unpleasant reality
that is sometimes downplayed by industry representatives.
Credit Counseling is a debt management program where you make a
single monthly payment to an agency. In turn, that agency
distributes the money to your creditors on your behalf, ideally
at lower interest rates so you can pay off the debt faster.
Credit Counseling should not be confused with Debt Consolidation,
Debt Settlement, or Debt Termination. Each of these debt programs
takes a very different approach from Credit Counseling.
Of all the available debt options, Credit Counseling is by far
the most popular, with millions of Americans participating. Does
this mean its the best choice for most people struggling with
debt? No! There are numerous problems with this approach.
In recent years, the Credit Counseling industry has been heavily
criticized by impartial consumer groups like the Consumer Federation
of America. But these criticisms often miss the mark entirely. They
usually focus on the aggressive companies that use their non-profit
status to trick consumers into thinking they are charitable organizations,
or even that their services are free of charge. In reality, these
outfits charge hefty voluntary contributions, often
adding up to hundreds of dollars, plus steep monthly fees as well.
However, Im not talking here about the bad companies who
provide little or no actual counseling, or the
ones that are only in business to make their owners rich.
No, Im talking about serious problems with the actual
business model itself. So lets take a closer look at
how Credit Counseling works.
Lets say you owe $25,000 on several different credit cards.
Lets also assume your average interest rate before you enrolled
was 20% (which is actually low these days, especially if youve
missed any payments). Your minimum monthly payments are $500, which
youve been struggling to keep up with. At this rate, it will
take a whopping 109 months (more than 9 years) to pay off your debts,
assuming you dont miss a single payment along the way.
You enroll in a Credit Counseling program that promises to get
you out of debt faster. But does it? Assuming your creditors agree
to participate in the program (not always the case), the real key
is the concession they will grant on your interest rates. In prior
years, creditors looked more favorably on Credit Counseling and
they offered steep discounts off the normal interest rates. But
lately they have squeezed the industry, and the concessions are
not so good any more. Currently, most of the major players will
reduce interest rates down to a range of 7% on the low side to 18%
on the high side. Well use 12% as the average.
So if you keep your payments at $500 per month at the new 12% rate,
how long will it take? First, we need to deduct the monthly
fee charged by the agency. In this example, well use
a fee of $25 per month, so $475 of your $500 will go toward
debt reduction. The good news is youll be out of debt
faster. The bad news is that it will still take 75 months
(more than 6 years) to become debt-free.
But what happens if you cant keep up with that $500 per month?
After all, you sought help from a credit counselor because you were
struggling financially, right? Lets say you drop down to $450
per month. After deducting the $25 monthly fee, that leaves $425
toward your debt plan. Now youre looking at 90 months (7 years
& 6 months), which is not much better than the 109 months you
started out with.
So how can credit counselors claim to cut your payments in half?
Good question. If you dropped down to $250 per month, youll
never pay off your debt! At 12% interest, the debt will climb
faster than your $250 per month can reduce it. The lowest
you could go would be $300 per month. However, it would now
take 20 years to pay off the debt, hardly an improvement!
In order to truly cut your payments in half, down to $250 in this
example, the agency would need to completely eliminate all interest!
And even then, it would still take more than 9 years to pay off
the balance! So the ads claiming you can cut your payments in half
are simply false.
Bear in mind here that in our example, were assuming youre
working with a good company that charges low fees and actually obtains
good interest rate concessions from all of your creditors. Even
with the best of credit counselors, youre still looking at
a 5-9 year program to pay off your debts.
Thats why Credit Counseling is usually only effective for
people with short-term financial problems. Consumers with long-term
financial instability have trouble keeping up with the regular payment
stream required to make these programs work. The result? Even the
most favorable statistics show that about 3 out of 4 people drop
out of Credit Counseling programs before completing them.
If you do decide to join one of these programs in order to
obtain some short-term relief, be sure to do your homework
first. Here are a few tips to help in your selection:
- Look for a company that actually provides old-fashioned
budget advice and counseling. If they want to sign you up
right away without first understanding your budget situation,
move on!
- Obtain copies of the contract and read it carefully before
signing up. Make sure you understand all of the fees involved.
Are there enrollment fees? Voluntary contributions?
Monthly fees? Extra fees per account? These hidden fees
can add up to big bucks.
- Make sure they work with all the creditors on your list
and not just some of them.
- Dont be fooled by non-profit status.
That doesnt guarantee youre dealing with a good
company. And it certainly doesnt mean the service
is free!
- Aim to find a local company that you can visit in person.
Check out your target company with the local Better Business
Bureau.
- Make sure they provide support after the sale. Try calling
their customer service number to see if you can get through
promptly.
Remember, you can eliminate your debts if you take a disciplined
approach to your finances, make a budget and stick to it,
and dont use your credit cards unless you can pay off
new balances in full each month.
Good luck in your financial future!
Charles J. Phelan has been helping consumers become
debt-free without bankruptcy since 1997. A former senior executive
with one of the nations largest debt management firms,
he is the author of the Debt Elimination Success Seminar,
a five-hour audio-CD course designed to teach consumers how
to choose the correct debt program for their financial situation.
The course also teaches consumers a do-it-yourself approach
to debt resolution that saves
$1,000s in fees and interest. http://www.zipdebt.com/article1
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