What to Know About Free Credit Counseling
by Richard Cole
Credit counseling and debt consolidation is now a major industry because of requirements in bankruptcy laws, as well as economic downturns that have squeezed consumers. Free credit counseling can consolidate loans, reduce payments and interest and restore the consumer's credit rating. But some free credit counselors have been accused of not working in the consumer's interest and hiding the true cost and risks of the programs. In some cases, credit counseling can hurt the consumer's credit rating rather than help.
How counselors are paid
Free credit counselors are generally paid by the creditors, who pay fees for each consumer who uses the service. Those fees can range from 5 percent to 15 percent of money recovered, so the more money the counselors can get from the consumer, the more money they make. The practice has led some critics to accuse counseling agencies of serving the creditor rather than the consumer.
Many free counseling agencies advertise themselves as non-profits. But because of their close relationship with creditors, the federal government has taken a harder look at their non-profit status.
How credit counseling works
Credit counselors generally create a debt management program, or DMP, for a consumer who is in trouble with credit card and other payments.
Typically, the DMP reduces the consumer's total monthly payments, usually by consolidating them into one payment. At the same time, the interest is reduced from as high as 30 percent down to 5 percent or 10 percent. A successful program can reduce the time to pay off credit card debt from 20 years down to three to five years.
In some cases, the DMP allows the consumer to "re-age" his account, meaning it will show on credit ratings that he is now paying his debts on time. That does not eliminate previous delinquencies, however.
The federal government has cracked down on some credit counseling abuses, but others are still reported. Some consumers report discovering hidden fees in their payments. Others are told falsely that the DMP will immediately restore a good credit rating.
Consumers who are up to date on payments but are simply trying to reduce interest rates can also run into trouble. In some cases, the credit counselor will tell the consumer to immediately start paying the counselor. If payments to creditors are due before the credit counselor can make an agreement with those creditors, the consumer will have late payments, which will hurt her credit rating.
Because credit counseling agencies are paid based on the money they recover from consumers, some counselors have been accused of steering consumers away from bankruptcy even thought it would be a better option.