Credit counseling

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Credit Counseling is a process of educating consumers about how to use credit appropriately to avoid incurring debts that cannot be repaid.

Many credit counseling services will also negotiate with creditors to help their clients set up payment plans or reduce their total balances due.

History of credit counseling

In the United States, the first credit counseling agencies were created in 1951, when credit grantors created The National Foundation for Credit Counseling, or NFCC. Their stated objective was to promote financial literacy and help consumers avoid bankruptcy.

In the late 80’s and early 90’s, the number of credit and debt counseling agencies in America increased significantly. An antitrust lawsuit was filed against the NFCC, arguing that the presence of creditors on the NFCC’s Board of Directors constituted monopolistic practices. As a result of this litigation, creditors agreed to fund non-NFCC member agencies as well.

In 1993, the “Association of Independent Consumer Credit Counseling Agencies,” or AICCCA, was founded, citing a need for “industry-wide standards of excellence and ethical conduct.” This formally organized the NFCC’s competition.

The credit counseling industry’s third major trade organization is its largest: the American Association of Debt Management Organizations, or AADMO.

Not all credit counseling agencies belong to a trade organization; there are well over 1,000 active credit counseling organizations in the United States.

Along with AICCCA and AADMO member agencies, the NFCC-member agencies, known as “Consumer Credit Counseling Services” or CCCS, offer financial literacy education and budgeting advice, as well as participation in “Debt Management Plans,” a debt repayment plan that can in some cases offer consumers reduced minimum monthly payments, reduced or waived fees, and reduced interest. The average duration of a Debt Management Plan is 48 months, during which the consumer must forgo all credit borrowing. Debt management plans do not negotiate down the principal balance of the consumer’s debt.

During a Debt Management Plan, the credit counseling agency may receive some compensation from the creditors to whom the debt payments are distributed. This funding relationship has led many to erroneously conclude that credit counseling agencies are merely a collections wing of the creditors. Known as “Fair Share,” these voluntary contributions from the creditors were originally set at 15% of the amount recovered. In recent years, Fair Share contributions have dwindled steadily, with contributions of 4-6% being the most common. Many creditors make no Fair Share contributions at all; most credit counselors, including all NFCC-member agencies, will still work with these creditors.

In 2005, the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 made credit counseling a requirement for consumer debtors filing for Bankruptcy in the United States. In order to meet this requirement, during the 180-day period preceding the filing of bankruptcy, the debtor must complete a program with an approved nonprofit budget and credit counseling agency. Such a program may include, but is not limited to, one counseling session conducted by phone or over the internet.

Criticism of credit counseling

With the sharp increase of credit counseling activity in the early 1990’s, abuses by certain credit counseling organizations led to criticism of the entire industry.

The Federal Trade Commission has filed lawsuits against several credit counseling agencies, and continues to urge caution in choosing a credit counseling agency. The FTC has received more than 8,000 complaints from consumers about credit counselors, many concerning high or hidden fees and the inability to opt out of so-called “voluntary” contributions.

The IRS also has weighed in on the subject of credit counseling, and has denied nonprofit 501(c)(3) tax-exempt status to some agencies. Audits of nonprofit credit counseling agencies by the IRS are ongoing.

Congress has also investigated the credit counseling industry, and issued a report that said while some agencies are ethical, others charge excessive fees and provide poor service to consumers. The report also stated that NFCC member guidelines, if applied to the entire credit counseling industry, would go a long way toward eliminating the abuses they uncovered in some parts of the industry.

Other organizations have voiced criticisms of the credit counseling industry, often citing the Fair Share funding model as evidence that credit counselors serve the interests of the creditors over the interests of consumers. Credit counselors respond that their job is not to take sides but to negotiate with all parties equally to help successfully resolve debts. They further argue that the steady decline in Fair Share funding belies the notion that creditors are in control of the credit counseling industry.

Another common criticism of credit counseling is the false assertion that participating in a Debt Management Plan will ruin a consumer’s credit. Fair Isaac Corporation, the company that pioneered the use of credit scores, states that participation in a Debt Management Plan has no effect on one’s credit rating.

In a report issued in 2003, the National Consumer Law Center and the Consumer Federation of America accused credit counseling agencies of “improper advice, deceptive practices, excessive fees and abuse of their nonprofit status.”

Many of the most vocal critics of credit counseling are lawyers and lawyer-funded groups, which view credit counselors as opponents because of their stated goal of helping consumers avoid bankruptcy.

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