Credit Counseling

What It Means

Credit counseling, referred to as debt counseling in many English-speaking countries, is a process in which a credit-counseling agency helps a debtor (a person in debt) make payments to his creditors (institutions, such as credit card companies and banks, to which a debtor owes money). A person needs credit counseling when he or she can no longer afford to make the minimum monthly payments on his consumer debts. (Consumer debt is defined as all nonmortgaged loans, which means that it does not include house payments.) This often happens when a person acquires several credit cards and reaches the credit limit (the maximum dollar amount the person is allowed to charge to the card) on each of the cards.

Such a person is in danger of having to file for bankruptcy. Bankruptcy is a legal term meaning that the federal government has officially recognized that an individual can no longer pay his or her debts. A person who successfully files for bankruptcy is relieved of some debt and is put on a government-monitored payment plan to meet the rest of the debt. Credit counseling is aimed at helping people avoid bankruptcy.

When Did It Begin

In the United States credit counseling began in 1951, when the National Foundation for Credit Counseling (NFCC) was established by the nation’s leading creditors. The organization’s mission was to educate clients in matters of finance and to help individuals reduce debt and thereby avoid bankruptcy. Most early credit counseling occurred in face-to-face sessions. As more Americans accrued unmanageable debt, however, face-to-face counseling for all of the people in need of debt relief became impossible.

By the early 1990s there were approximately 200 credit-counseling firms, most of which worked under the auspices of the NFCC. The number of credit-counseling agencies began to increase drastically in 1993, when the Association of Independent Consumer Credit Counseling Agencies, or AICCCA, was founded. This organization adopted a telephone-service model, and within a decade there were more than 1,000 credit-counseling organizations in the United States. Most of these new agencies did not work under the auspices of the NFCC.

More Detailed Information

Credit counseling has two components: education and debt management. First, counselors teach their clients how interest rates (the fees that lending institutions charge for their loans) affect monthly payments. Second, counselors put their clients on debt management plans (DMPs), which reorganize a client’s payments to creditors. Most DMPs consolidate the debtor’s loans. This means that the counseling agency combines all of the client’s monthly payments on consumer debt (for example, car payments, student loans, and various credit card payments) into one monthly payment. The client makes this payment directly to the credit-counseling agency, and the agency distributes these funds to the various creditors. A DMP is structured to last a fixed period of time, usually three to six years, and during this time the debtor is not permitted to accrue new debts by, for instance, opening a new credit card account or taking out a loan for an automobile.

Typically the total amount of the debtor’s single payment to the credit-counseling agency is less than the sum of the person’s separate monthly payments on consumer debt. For instance, a person may have monthly payments of $500 on student loans and $300 on a car plus a minimum payment (the lowest permissible monthly payment on a larger debt to a credit card company) of $100 on a Visa credit card, a minimum of $200 on a MasterCard, and a minimum of $300 on a Discover credit card. In this example, the sum of the debtor’s payments to creditors is $1,400 per month. These monthly payments to creditors do not include the individual’s living costs, such as a mortgage (monthly payments on a house) or rent for an apartment, food, utilities (payments to water, power, telephone, and other companies that provide services to homes), and other financial responsibilities, such as the costs associated with raising children. If the debtor earns $2,000 per month at a job, he or she would probably not be able to make payments to all these creditors each month. A counseling agency would use a DMP to help the debtor establish a monthly budget that took into account the person’s entire set of financial responsibilities. Instead of making a series of separate payments to each of the creditors totaling $1,400, the debtor might send one check of $1,000 each month to the credit-counseling agency.

People on DMPs usually end up paying less on their debts than they actually owe. This happens because creditors would rather acquire some portion of the money owed to them than nothing at all. In many cases creditors help fund credit-counseling agencies, which means that lending institutions, such as banks, contribute money to help operate these organizations. The counseling agencies also make what is called a Fair Share arrangement with creditors. According to these arrangements the counseling agency keeps a portion of the client’s monthly payment, sometimes as much as 30 percent. In the example above the credit agency would keep $300 of the $1,000 paid on the debtor’s DMP.

Recent Trends

Consumer debt began rising significantly in the 1980s as Americans began taking out larger mortgages on houses, leasing more expensive automobiles, and paying for more goods and services on credit cards. By 2005 Americans owed a total of nearly $750 billion to credit card companies alone. With this drastic rise in debt, the number of credit-counseling agencies in the United States also increased significantly. Unfortunately, many of these new organizations were corrupt, and there was a crisis in the credit-counseling industry in the early 2000s. Preying on Americans in need of debt relief, many fraudulent businesses advertised themselves as nonprofit organizations that would help consumers restructure payment plans. These organizations often charged a high initial fee (which the organization kept) and lied about how effective the debt management plan would be in reducing the client’s outstanding loan payments. At the same time, credit card companies had begun to decrease the percentages of their Fair Share arrangements with many legitimate credit-counseling agencies, which reduced the number of people these legitimate agencies could serve. In 2005 the U.S. Congress passed a law that required individuals to seek credit counseling from a government-approved organization before filing for bankruptcy.