 Credit counselors are falling all over themselves to help you out of debt, but some do more harm than good. Here’s what you need to know, including whether you need it and the red flags for rip-offs.
Randy is deeply in debt and desperate. He's seen all the television ads from credit counseling services that promise to help him, and he's also been approached by a company that assures him it can painlessly make his debts go away. Is this, he asked me in an e-mail, too good to be true? Often, the answer is yes.
Randy's thinking of entering a world that's fraught with fraud, misrepresentation and controversy. Debt counseling has become a $7 billion industry, but not all the players are legitimate.
The best credit counseling can help people who are behind on their debts get back on their feet. Fly-by-night outfits can disappear with your money, and what remains of your credit rating. In between the two are a whole fleet of operators who may or may not leave you better off than you are now.
The morphing world of credit counseling
A decade ago the industry was dominated by the National Foundation for Credit Counseling, whose nonprofit affiliates -- usually known as Consumer Credit Counseling Services -- negotiated lower interest rates and payment plans for people who had fallen behind. Today you can find the Consumer Credit Counseling Service in just about any city.
But the services now have plenty of competition. A rise in consumer debt in the 1990s helped spawn hundreds of rivals, many with million-dollar advertising budgets, slick Internet come-ons and sound-alike names.
Some do a good job of negotiating repayment plans. Others charge fat upfront fees, pay their executives even fatter salaries and pocket much of the money that could be going to pay off creditors. An increasing number target people who aren't even late on their payments, but who are simply disgruntled about their interest rates.
The worst aren't credit counselors at all. Usually billing themselves as specialists in "debt settlement," they promise to help you get rid of your debts for pennies on the dollar -- after you pay an upfront fee that can be $3,000 or more. Typically, by the time I hear about these companies, they've already absconded with people's cash, disconnected their phones and set up shop somewhere new with a different name.
Who needs credit counseling?
Obviously, all these outfits are finding plenty of eager customers. Americans' debt loads have been running at record levels, and bankruptcies are high.
It's hard to get an accurate bead on how many people signed up for debt repayment plans through credit-counseling services. Of those in debt repayment plans, said Lydia Sermons-Ward, spokeswoman for the National Foundation for Credit Counseling, about half were expected to successfully complete their plans. The other half were expected to drop out, with some of those filing for bankruptcy.
Typically, counseling services negotiate lower payments with credit-card companies and other lenders, then make the payments using a check or electronic funds transfer sent to them by the consumer each month.
Most of the counseling services' fees are paid by the lenders themselves, which send back to the services a portion of the payments received. This has led some critics to charge that credit counseling is just a tool of the lending industry.
The payment system, known as "fair share," has certainly encouraged the growth of credit counseling services. And some agencies, driven by competition, are now openly courting consumers who haven't fallen behind on their debts by promising lower interest rates. This development has angered credit-card companies and often hurts consumers, who may find out too late that such plans can hurt their credit ratings and are often unnecessary.
Are you in danger?
So let's make this clear: If you're able to pay your bills and are current on all your accounts, you almost certainly don't need credit counseling. If your interest rates are too high, you usually can negotiate a lower rate with your credit-card companies just by asking -- or threatening to move your account elsewhere.
Here's when you might think about full-scale credit counseling:
- You can't pay the minimums on your credit cards.
- You're consistently late paying one or more of your regular bills.
- You're being hounded by creditors and collection agencies.
- Your efforts to work out reasonable repayment plans with your creditors have failed.
Be warned: If you're too far in debt, credit counseling may not be able to help. There are limits to how little your creditors will accept, and a credit counseling service may not be able to cut your payments enough to either give you breathing room or get you out of debt. If that's true, bankruptcy may be the best of bad options.
Your payments also shouldn't stretch on for years. The typical plan takes two to four years to complete. Responsible credit counselors say bankruptcy is usually the better option if the repayment would take more than five years.
What to watch out for
Once you've decided you want credit counseling, you should investigate the company or service carefully before signing up. Red flags to avoid include:
- Big upfront fees. Consumer Credit Counseling Services typically charge a $10 set-up fee. If you're paying a lot more, you may be the one who's getting set up, unless you're getting extensive and personal money coaching that could justify the fee.
- No accreditation. Legitimate credit counseling firms are affiliated with the National Foundation for Credit Counseling or the Association of Independent Consumer Credit Counseling Agencies.
- Delayed or missing payments. Some companies pocket your first months' payments as a fee, rather than passing the money on to your creditors. Missing payments can hurt your credit rating. Find out how much of each monthly payment is going to your creditors, and when it will be sent to them.
- Unrealistic promises. Some companies falsely promise that you can settle your debts for little or no money, without hurting your credit rating. Legitimate credit counseling services help you pay back what you owe, albeit at lower interest rates, and acknowledge there may be some affect on your credit rating and ability to obtain new credit.
What counseling can do to your credit
Here's another controversial topic. You may have heard that credit counseling will trash your credit report or even that it's "worse than bankruptcy." Neither is really true.
Credit counseling may have some effect on your credit, or it may have none at all. Some lenders may not want to do business with you after you've completed your plan, but others will.
Contrast that with a bankruptcy, which is viewed by almost all mainstream lenders as a huge negative on your credit report. These lenders, who prefer to deal with consumers with good credit, typically won't do business with you for the 10 years the bankruptcy remains on your file.
What happens to your credit during counseling largely depends on how your lenders report your account to the credit bureaus.
First USA, the credit-card giant, reports its customers as delinquent on their bills until they make three consecutive payments of the new minimums negotiated by their credit services, said spokesman David Webster. Citibank, by contrast, simply adds a note to the credit bureaus' files that the customer is enrolled in credit counseling.
Being reported as late or delinquent can certainly hurt your credit score, the three-digit number widely used by lenders to determine creditworthiness. A simple notation about credit counseling probably won't. The credit score formula used by most lenders, known as FICO, now ignores any reference to credit counseling that may be in your file, said Craig Watts, spokesman for FICO creator Fair Isaac & Co.
Even some lenders that were traditionally suspicious of credit counseling have loosened their stance. More mortgage lenders are willing to lend to people who have successfully completed repayment plans, said mortgage broker Allen Bond, president of the California Association of Mortgage Brokers' Southern California chapter.
Some lenders say they even view credit counseling as an encouraging sign that a customer is getting his or her debts under control. Citibank, the largest issuer of credit cards, says people who have fallen behind on their payments often improve their status in the company's eyes by enrolling in -- and sticking with -- a debt repayment plan.
"We always viewed that as a positive," said Citibank spokeswoman Maria Mendler. "We've seen that for people who enter these programs, there's a significantly lower rate of default."
That said, there are still some lenders who refuse to deal with anyone who has enrolled in credit counseling. And if you fell behind on your payments before you entered credit counseling, you'll find those late payments will still affect your credit score even after you've paid off your debts.
As you can see, there are no easy answers for people who get in trouble with credit. Once you're there, make sure to evaluate your options carefully, and don't make a bad situation worse.
By Liz Pulliam Weston |
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137 days ago by deepak [