Credit counseling services help consumers with overextended credit, and high credit card debt levels improve financial management skills. Credit counselors work with consumers to regain control of their finances and pay off existing debts through a debt management plan or DMP.
When credit card balances surpass $10,000, it becomes increasingly challenging to pay off creditors because the monthly interest charges make up the most of your minimum payment. For instance, you might pay $200 a month towards your debt, but the interest could be over $180, leaving little going toward principal reduction.
When you face this hopeless situation, most people cannot afford to make large enough payments to eliminate the balances. It might be time to investigate debt relief options that will help you tackle your high-interest debt.
Credit counseling is one way to resolve high credit card debt levels, personal loans, or even past-due medical bills. Here is what you need to know about credit counseling before you enroll in a debt management plan.
- Credit counseling companies offer free financial education materials and courses to teach you how to manage money, get out of debt, buy a home, and navigate bankruptcy.
- Credit Counselors also administer Debt Management Plans (DMP), which are programs approved by creditors that establish a repayment plan of the full balance plus some interest over 60 months to eliminate unsecured debt.
- Credit counseling agencies negotiate lower interest rates and waived fees to reduce some of the balance, but your monthly payments may be higher than your current minimum monthly payment on enrolled accounts.
- If you are unable to complete a Debt Management Plan, creditors will reinstate any reduced interest accruals and waived fees, which can substantially increase the balance you owe.
What is Credit Counseling?
Credit counseling provides support and resources to help you learn how to manage your finances and improve your circumstances. It is not necessary to encounter a financial crisis to participate in credit counseling, and there is no income threshold required to qualify. If you want to buy a home but need assistance improving your credit, are struggling to manage multiple credit card payments, or can’t get on track with a budget, credit counseling could be a viable solution.
Using credit counseling services could help prevent bankruptcy, avoid foreclosure, and teach you the financial skills required to thrive financially. Agencies seek to identify the root cause of your financial distress and give you the tools necessary to prevent future financial problems. Services include counseling, educational material on financial matters, and financial education courses.
Professional credit counseling services also help you get out of debt. A debt management plan will help you pay off unsecured debts such as credit cards or medical bills by paying creditors through the program.
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What Services do Credit Counseling Agencies Provide?
- Review of your credit, including how to read your report and tips on raising your score
- How to create a budget, track spending, and identify ways to save money
- Money management guidance
- Assistance with credit usage and management
- Court Approved courses required for bankruptcy (meets the pre- and post-bankruptcy filing requirements)
- Classes that could qualify you for first-time homebuyer grants
- Counseling services for bankruptcy, housing, personal, and payday loans.
- Create and administer debt management plans
Services Credit Counseling Agencies CANNOT Provide
- Credit repair services
- Assistance with past-due secured debt, such as auto loans
- Stop existing court action, including pending lawsuits, existing wage garnishments, or default judgments
Is Credit Counseling the Best Option for Your Circumstances?
Debt Management Plans offered by Credit Counseling Agencies are best suited for consumers struggling to achieve financial stability and who need help managing high levels of credit card debt.
To qualify, you must be able to document sufficient income to support the repayment of the full amount of your debt, plus some interest, within five years. You could save money through lower interest rates and waived fees, and paying off your debt faster, thereby reducing the amount of interest you would otherwise pay.
For consumers with a manageable amount of debt, and sufficient income to repay all their debt plus some interest in five years or less, a credit counseling program may be an option to explore further.
How Will Credit Counseling Affect Your Credit?
Credit scoring companies like FICO use five key measures to tabulate your credit score:
- Payment history
- Debt balance to the line-of-credit ratio (also called the utilization ratio)
- The mix of loans and lines of credit
- Length of credit history
- New credit
Credit counseling requires you to close enrolled accounts, which will raise your utilization ratio and could shorten the length of your credit history. If late payments occurred before enrollment, you would see a smaller initial decline because the inconsistent payment history already lowered your score. Having high balances in relation to your credit limits would also drive down your score, lessening the impact of closed accounts. Missing payments between enrollment and the time a creditor approves your DMP will result in reported late payments, which will almost certainly lower your score.
How to Find the Best Credit Counseling Agency for Your needs
Most credit counseling agencies operate as non-profits. Reputable agencies seek to increase your understanding of financial matters and help you manage your money and follow a budget. Other standard services include free educational materials and a free credit counseling session to discuss your financial needs before making any debt relief recommendations. Avoid agencies that recommend a debt management plan before assessing your needs or those that do not offer basic educational services.
Many states require certifications, annual reporting, annual audits, and bonding to protect consumers. At the federal level, HUD certifies companies that meet its standards. The Department of Justice maintains a list of HUD-approved credit counseling agencies you can find here.
Questions You Should Ask Before Selecting a Credit Counseling Agency
- What Services are Offered by Your Credit Counseling Agency? Consider both your immediate and long-term needs, which might include budgeting, paying off debts through a DMP, or protection from foreclosure.
- Is Your Company Registered as a Non-Profit Credit Counseling Agency? Non-profit agencies undergo annual audits and receive accreditation from federal agencies like HUD. Companies may also work with communities to raise the level of financial education through newsletters, workshops, and financial literacy programs.
- Does Your Credit Counseling Agency Offer Free Educational Materials? You can expect to receive complimentary educational literature on a wide range of financial topics beyond how to budget and get out of debt.
- Do the Services Offered by Your Agency Provide for Both Immediate and Future Financial Needs? Credit counseling is generally not a one-time event. Future needs could include buying a home or help to face another financial crisis like preventing foreclosure and education required to file a bankruptcy petition.
- How Much do the Services Offered by Your Agency Cost? Most agencies offer a free counseling session and free literature on financial matters. However, you can expect to pay both an enrollment fee and monthly fees while in a debt management plan, and certain court-approved courses for bankruptcy counseling or other specialized services also come with an associated cost.
- What Accreditations do Credit Counselors Have? Credit counselors complete continuing education training annually. The National Association of Certified Credit Counselors offers training and certification for Credit Counselors and sets national standards certified credit counselors must follow.
- Is Your Credit Counseling Agency Registered in My State? Companies must register in every state it serves clients. Additionally, many states have licensing and bonding requirements companies must secure before doing business.
What Happens in a Credit Counseling Session?
Credit counseling sessions provide an outside perspective on your current financial situation.
The counselor can teach you how to read a credit report, help you create a budget, provide money management strategies, and answer financial questions. After reviewing your income and expenses and drafting a household budget, the counselor might also recommend a debt management plan (DMP) to facilitate your debt elimination goals.
Most counseling agencies offer multiple ways to connect with a credit counselor. Options may include a phone call, video conference, or in-person session.
Before setting an appointment, a little preparation will help you get the most out of your free credit counseling session. Start by gathering essential financial documents so you can have an honest discussion about the state of your finances. Be sure to gather and review the following information prior to your credit counseling session:
- Current pay stubs. Understanding your total income is essential for both budgeting and debt reduction. Unless your income fluctuates, it is sufficient to have 30 days’ worth of income.
- What you owe. Create a list of current debts: include who you owe, the outstanding balance, interest rate, due date, and monthly payment.
- Monthly expenses. Have a list of expenses. Include monthly, quarterly, and annual bills. Then estimate costs for things like food, transportation, and entertainment for an accurate assessment of your living costs. Bank account statements and credit card bills are often helpful in identifying who you pay and how much you spend.
- Recent credit report. Visit annualcreditreport.com before your session and print a copy of your credit report. The credit counseling agency can also get a copy of your credit file without impacting your credit score.
What is a Debt Management Plan?
When you struggle to repay creditors, a credit counseling agency will often recommend a Debt Management Plan (DMP). The DMP is a separate program from credit counseling and the other services offered. You can participate in the free credit counseling session, get help with your budget, or take a financial education course without enrolling in a DMP.
A Debt Management Plan specifically addresses unsecured debts such as credit card bills, personal loans, or medical debt. To qualify for the program, you must have enough income to repay your creditors in full, with some interest, within five years. You choose which accounts you want help with, and you must close any accounts you enroll in a debt management plan.
After enrolling, the counselor will contact your creditors to establish a repayment plan based on the amount owed and how much you can pay each month. The counselor will also try to negotiate a lower interest rate and get fees and penalties waived to save you money.
Going forward, you will make a single monthly payment to the credit counseling agency, and they will distribute funds to your creditors based on the agreed schedule. You also agree not to acquire any new credit accounts while in the program.
In some cases, creditors require you to make payments to your DMP before agreeing to any fee waivers or interest rate concessions. Missing payments before creditors accept the DPM could lead to late fees or penalties, and the creditor will report any missed payments to the credit bureaus, resulting in a negative impact on your credit score.
While in the program, you will continue to receive statements allowing you to monitor your progress. Concessions such as lower interest rates and waived fees are contingent on completing the program.
It is vital that you only enroll in the program if you can afford the monthly payment and are certain you will be able to complete all payments over the term of the debt management plan. Failure to make all payments in a timely manner during the duration of the debt management plan may result in your creditor reversing any waived fees and reapplying deferred interest charges, setting you back financially.
How Long Does a Debt Management Program Last? You must repay all creditors in full, plus some interest, within 60 months.
What Can You Expect After Completing a Debt Management Plan? Paying off your debts is a significant accomplishment. After completing the program, you will have more money each month for other financial priorities. For long-term success, you must maintain a budget and practice the financial skills you learned.
What Happens if You Cannot Finish Your Debt Management Plan? If you cancel your DMP, the agency will notify creditors of the change in status. At that time, you will begin paying creditors directly. The cancellation will void any concessions, such as waived fees and lower interest rates, and those fees and deferred interest may be reapplied to your account.
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If I Can’t Qualify for Credit Counseling, Are Other Debt Relief Options Available?
Since credit counseling requires to pay back all of your debt, plus some interest, in just five years, many people with high debt loads and limited income find it hard to qualify for and even harder to successfully complete a debt management plan. For those with little to no income, bankruptcy may be a more realistic option, but for those with a demonstrated hardship such as the loss of a job or reduction in hours, high medical expenses, disability, loss of a loved one, or a recent divorce, debt negotiation or debt settlement program may bring the payment relief needed.
Chapter 7 bankruptcy could discharge debts without requiring you to repay creditors. You must qualify for Chapter 7 by passing a means test or earning below the mean income in your state based on your family size. It costs several thousand dollars in court costs and attorney fees to file a petition. The process could discharge qualified debts within six months. The court may liquidate all non-exempt assets before discharging debts, which could compromise your home or vehicle. There are serious consequences to bankruptcy, including the loss of non-exempt assets and very poor credit for the next decade.
Chapter 13 bankruptcy does not have the strict qualifications found in Chapter 7. Often called the “wage earners” bankruptcy, Chapter 13 allows you to retain more assets and gives you time to catch up on loans attached to assets you wish to keep. You will be required to work with a bankruptcy court trustee to establish a repayment plan based on an approved budget that directs all disposable income toward debt reduction. The court trustee will oversee payments to creditors for the next three to five years. At the end of the repayment period, a judge will discharge any remaining balances.
Debt Settlement helps consumers facing financial hardship that prevents you from repaying creditors in full. Once enrolled in the program, you make payments into a special purpose trust or savings account which you own, and control. Once you have adequate balances available to settle accounts, a professional debt negotiator will contact your creditors and negotiate a settlement of your accounts for less than the full balance owed. Debt Settlement programs typically last 3-5 years, and your monthly program payment is usually less than the combined minimum monthly payments on your enrolled accounts.
Should I enroll in credit counseling?
Credit counseling helps consumers with enough income to pay off credit balances within five years. Delinquent payments are not a requirement for enrollment.
How does credit counseling affect my credit?
All forms of debt relief can negatively impact your credit. Having too much debt, late payments and closing accounts will all lower your credit score. Credit counseling typically affects your score because you must close accounts enrolled in the debt management program, increasing your credit utilization. The effects are temporary and will improve as you pay off creditors.
What do credit counselors do?
Trained credit counselors can help with budgeting, money management, credit issues, and paying off credit card debt through a debt management plan.
Should I pay off my debt or settle my accounts?
When you can repay creditors in full, the companies expect you to do so. However, a financial hardship could prevent you from paying creditors in full. Settling credit card debt or personal loans are a legal remedy available when you face a financial difficulty that makes you unable to keep payments current.
Which is better: credit counseling or debt settlement?
Credit counseling and debt settlement are debt relief programs that help two very different types of consumers. Credit counseling requires you to repay 100% of your debt balances, plus some interest, within five years. You save money through lower interest rates and waived fees, but usually have to pay more than the minimum payment each month on enrolled accounts. Debt settlement helps you if you cannot repay the debt in full due to a financial hardship. Creditors will agree to a discounted lump-sum or term settlement after you demonstrate that you cannot pay the total amount.
How long will it take to rebuild my credit after debt settlement?
Derogatory marks, such as a late payment, remain on your credit file for seven years from the first missed payment, provided you never bring the account current. Credit scoring companies such as FICO place the highest weight on adverse events occurring in the previous 12 months. Keeping one or more accounts open and current can speed up the recovery of your credit score, after completing a debt settlement program.