"Cut Your Payments
in Half!" the headline screams. "Consolidate Your Bills into One Low
When you see ads
like this, they are often from Credit Counseling firms. In this
article, I'll explain the principles behind the Credit Counseling
approach and discuss the main problem consumers face when they join
one of these programs.
First, let's get
our definitions straight. The term "Credit Counseling" is actually
quite misleading, since it has nothing to do with preserving or
improving your credit score. In fact, Credit Counseling will often
damage your credit, an unpleasant reality that is sometimes
downplayed by industry representatives.
is a debt management program where you make a single monthly payment
to an agency. In turn, that agency distributes the money to your
creditors on your behalf, ideally at lower interest rates so you can
pay off the debt faster. Credit Counseling should not be confused
with Debt Consolidation, Debt Settlement, or Debt Termination. Each
of these debt programs takes a very different approach from Credit
Of all the
available debt options, Credit Counseling is by far the most
popular, with millions of Americans participating. Does this mean
it's the best choice for most people struggling with debt? No! There
are numerous problems with this approach.
In recent years,
the Credit Counseling industry has been heavily criticized by
impartial consumer groups like the Consumer Federation of America.
But these criticisms often miss the mark entirely. They usually
focus on the aggressive companies that use their non-profit status
to trick consumers into thinking they are charitable organizations,
or even that their services are free of charge. In reality, these
outfits charge hefty "voluntary" contributions, often adding up to
hundreds of dollars, plus steep monthly fees as well.
However, I'm not
talking here about the bad companies who provide little or no actual
"counseling," or the ones that are only in business to make their
owners rich. No, I'm talking about serious problems with the actual
business model itself. So let's take a closer look at how Credit
Let's say you owe
$25,000 on several different credit cards. Let's also assume your
average interest rate before you enrolled was 20% (which is actually
low these days, especially if you've missed any payments). Your
minimum monthly payments are $500, which you've been struggling to
keep up with. At this rate, it will take a whopping 109 months (more
than 9 years) to pay off your debts, assuming you don't miss a
single payment along the way.
You enroll in a
Credit Counseling program that promises to get you out of debt
faster. But does it? Assuming your creditors agree to participate in
the program (not always the case), the real key is the concession
they will grant on your interest rates. In prior years, creditors
looked more favorably on Credit Counseling and they offered steep
discounts off the normal interest rates. But lately they have
squeezed the industry, and the concessions are not so good any more.
Currently, most of the major players will reduce interest rates down
to a range of 7% on the low side to 18% on the high side. We'll use
12% as the average.
So if you keep
your payments at $500 per month at the new 12% rate, how long will
it take? First, we need to deduct the monthly fee charged by the
agency. In this example, we'll use a fee of $25 per month, so $475
of your $500 will go toward debt reduction. The good news is you'll
be out of debt faster. The bad news is that it will still take 75
months (more than 6 years) to become debt-free.
But what happens
if you can't keep up with that $500 per month? After all, you sought
help from a credit counselor because you were struggling
financially, right? Let's say you drop down to $450 per month. After
deducting the $25 monthly fee, that leaves $425 toward your debt
plan. Now you're looking at 90 months (7 years & 6 months), which is
not much better than the 109 months you started out with.
So how can credit
counselors claim to cut your payments in half? Good question. If you
dropped down to $250 per month, you'll never pay off your debt! At
12% interest, the debt will climb faster than your $250 per month
can reduce it. The lowest you could go would be $300 per month.
However, it would now take 20 years to pay off the debt,
hardly an improvement!
In order to truly
cut your payments in half, down to $250 in this example, the agency
would need to completely eliminate all interest! And even
then, it would still take more than 9 years to pay off the balance!
So the ads claiming you can cut your payments in half are simply
Bear in mind here
that in our example, we're assuming you're working with a good
company that charges low fees and actually obtains good interest
rate concessions from all of your creditors. Even with the best
of credit counselors, you're still looking at a 5-9 year program to
pay off your debts.
That's why Credit
Counseling is usually only effective for people with short-term
financial problems. Consumers with long-term financial instability
have trouble keeping up with the regular payment stream required to
make these programs work. The result? Even the most favorable
statistics show that about 3 out of 4 people drop out of Credit
Counseling programs before completing them.
If you do decide
to join one of these programs in order to obtain some short-term
relief, be sure to do your homework first. Here are a few tips to
help in your selection:
1. Look for a
company that actually provides old-fashioned budget advice and
counseling. If they want to sign you up right away without first
understanding your budget situation, move on!
2. Obtain copies
of the contract and read it carefully before signing up. Make sure
you understand all of the fees involved. Are there enrollment
fees? "Voluntary" contributions? Monthly fees? Extra fees per
account? These hidden fees can add up to big bucks.
3. Make sure
they work with all the creditors on your list and not just some of
4. Don't be
fooled by "non-profit" status. That doesn't guarantee you're
dealing with a good company. And it certainly doesn't mean the
service is free!
5. Aim to find a
local company that you can visit in person. Check out your target
company with the local Better Business Bureau.
6. Make sure
they provide support after the sale. Try calling their customer
service number to see if you can get through promptly.
can eliminate your debts if you take a disciplined approach to
your finances, make a budget and stick to it, and don't use your
credit cards unless you can pay off new balances in full each month.
Good luck in your
Charles J. Phelan
has been helping consumers become debt-free without bankruptcy since
1997. A former senior executive with one of the nation's largest
debt management firms, he is the author of the Debt Elimination
Success Seminar™, which
comprehensive instruction in do-it-yourself debt settlement that
saves $1,000s in fees.
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