Credit Counseling: Everything You Need To Know

Credit counseling could be the best first step to end your battle with debt in 2023. Consumer credit counseling is a nonprofit service that helps consumers who are overextended with high-interest rate credit card debt. It can be a fast and easy way to find the best solution to become debt-free that minimizes what you pay out of pocket. Learn everything there is to know about this service including the step-by-step process of credit counseling, how it can benefit you, and how to avoid credit counseling scams.

Table of Contents

What is credit counseling?

Credit counseling is a professional service that assists people in getting out of credit card debt. These services may also be referred to as debt counseling or financial counseling. All of these terms are roughly interchangeable.

The credit counseling process starts with a financial consultation. The counselor reviews your finances and helps you understand your various options for getting out of debt as quickly as possible as well as how to improve your financial literacy overall. The next steps will depend on your particular situation.

What do credit counseling services do?

• Answer questions about different strategies for getting out of debt
• Assist you in identifying the right solution for your immediate and long-term financial needs
• Help you eliminate your existing credit card balances—this may also include other unsecured debts, such as unpaid medical bills and payday loans
• Eliminate the hassle of collection calls. Once you enroll, you can pick up the phone and tell them you’re working with an agency. Collectors must then go through the agency
• Provide resources to build financial literacy
• Teach you how to budget and manage credit effectively
• Help you establish long-term financial stability

What can’t they do?

• Repair your credit (that’s a different service)
• Provide immediate debt forgiveness – Debt management programs (DMP) take about 36 to 60 payments, on average
• Negotiate settlements with your creditors – Some agencies may offer less-than-full-balance programs that only pay back a portion of what you owe, but these are preset agreements that creditors offer for customers facing severe financial hardship
• Provide direct assistance for other types of debt – Mortgage, back taxes, or student loans; however, they can refer you to other service providers
• Stop existing court actions regarding your debt – If a collector already sued you and won, the ruling stands

What to expect in a credit counseling session

A certified credit counselor will evaluate your debts, budget, and credit. You’ll also talk about your financial needs and goals. Then, they’ll help you identify the best method of getting out of debt considering your unique situation. In addition to teaching you how to better manage your money, they can actively help you reduce your debt by enrolling you in a debt management program (DMP). 

The first step in credit counseling will always begin with a consultation which can take between 30 minutes to an hour. Have your financial documents, like your most recent credit card statements, available for reference so that you can share all necessary financial information such as balances and interest rates. You will also need to share the last four digits of your Social Security number for a soft credit pull.

How does credit counseling work?

When faced with overdue notices, late fees, and collections notices, things can quickly become overwhelming. A common problem when people face financial challenges is that they don’t know what debt relief solutions are available to them. Most people don’t look into them until they’re already in debt.

Step 1: Contact a credit counselor

Certified credit counselors are trained to be knowledgeable about all available debt solutions. They can assess which debt relief strategy is best for your unique financial situation.  A credit counseling session is usually done over the phone. However, the consultation can also take place in person or start online by filling out a form detailing your situation

Step 2: Assessment of your financial situation

To start the credit counseling process, the counselor will ask for some basic information about your financial situation. Be prepared to share information including:

1. Your income
2. Current debts, including secured loans like your mortgage or auto loan
3. Monthly expenses – i.e. groceries, gas, entertainment, subscriptions… everything in your budget
4. Current balances on your credit cards as well as the APR on each account
5. Other obligations, such as payday loans and unpaid medical bills

In order for credit counseling to be truly effective, it’s vital to be completely honest with your financial situation. Withholding any information could drastically affect which debt relief option they recommend.

Step 3: Authorize a credit check

To complete the picture of your finances, the counselor will ask to run a credit check which allows them to review your report to see if you have collections or other items of note. This is a “soft” inquiry and does not impact your credit score.

Step 4: The credit counselor will make a recommendation

Once they have a good picture of your finances, the counselor recommends the types of debt relief services that would be best for your circumstance:

1. Debt management programs
2. Debt settlement
3. Consolidation loans
4. Balance transfers
5. Bankruptcy

Counselors are required to review all your options and only recommend the best solutions for your situation. In other words, nonprofit agencies don’t try to “sell” their program. This is why credit counseling is the best way to find a solution for paying off debt that fits your needs. You can get an unbiased, expert opinion about what you need to do to take control of your finances and ask questions about different solutions and learn how to minimize things like credit damage.

13 questions to ask during your free counseling session »

Will credit counseling hurt my credit?

Your credit score is not a factor in qualifying for credit counseling. There is no minimum score requirement to enroll in a debt management plan. In addition, when done correctly the program has either a neutral or positive effect on your credit. In other words, if you still have decent credit when you start the program, completing it won’t set you back.

It’s also worth noting that working with debt counselors won’t negatively impact your ability to qualify for new financing.  The initial consultation, even with a credit check, won’t affect your score. Even if you enroll in a DMP, you can still get approved for loans, such as a mortgage or an auto loan. The only limitation is that you cannot open new credit card accounts during enrollment.

It is important to note that while credit counseling does not have a negative impact on your credit score, completing a debt management program can. While the program helps you build a positive credit history, it closes your credit cards. Closing cards can drop your score if your score was high when you began the program. However, people with fair or bad credit generally see their scores improve over the course of the program.

Enrolling in a debt management program

A debt management program can significantly lower your monthly payments (though you’ll still need to pay off the full principal amount owed) and stop the damage to your credit score. How does credit counseling accomplish this? The credit counseling agency acts as a go-between for you and your creditors. They set up a repayment plan that you and credit card issuers agree on and work with creditors to reduce or eliminate interest charges and fees.

If a debt management program is the right option, you can enroll through the same agency you spoke to for the initial credit counseling evaluation. Here’s what you can expect:

Step 1: Decide which accounts to include in your debt management plan

All accounts included in a debt management plan will be frozen during enrollment and closed upon completion of the program. This means that any credit lines involved in DMP will be unavailable for further use. You will need to weigh whether having access to a credit card is worth any potential fees or other charges you might continue to incur by not including it in the management plan.

Most counselors will suggest including all existing credit card debt in order to get out of financial trouble as quickly as possible, but you might want to leave a card out of the program for emergencies or because you’re not behind on that account. Enrollment in a consumer credit counseling service is 100% voluntary so there’s no requirement on which debt accounts you must include. If you’re unsure whether you want to include a credit card in your debt management plan or not, you can wait and have your counselor add it to the plan later if you change your mind.

Married couples concerned about involving their spouse don’t need to worry. A spouse’s credit cards would only need to be included in the program if you hold those accounts jointly. If you have separate accounts or are strictly authorized users on each other’s accounts, then they would not need to enroll with you.

Step 2: Find a monthly payment that works for your budget

Together, you and a credit counselor set a monthly payment you can afford to make. This single payment will cover all the accounts that you include in your DMP. The counselor will also help you set up a formal budget if you don’t have one already. The goal is to ensure you can comfortably afford your monthly payments and your other expenses, so you won’t have any issues living without relying on plastic.

Step 3: The credit counseling team works with your creditors

Your counselors will reach out to each of your creditors with three goals:

1. Make sure your creditors agree to accept payments through the counseling organization.
2. Reduce or eliminate APR applied to your account.
3. Stop all penalties and fees.

This will help prioritize which balances get paid off first. Each creditor must sign off to include their account in the program. You will receive acceptance letters from each creditor saying they agree to the terms of your plan.

Step 4: The debt management plan officially starts once all creditors sign off

You make one monthly payment to the counseling organization which they then distribute to your creditors as agreed. Payments are usually handled through Direct Debit from your checking account. An agency will rarely accept payments online or by check. However, you usually have access to an online portal that tracks your progress and provides more information if you encounter any trouble. The monthly fee to enroll in the debt management plan will be included in this monthly payment.

Other benefits of a debt management program

Your organization should also provide free resources you can use to build financial literacy. The goal is to help you learn how to avoid financial hardship in the future and plan for long-term financial stability. You should receive information on how to budget, save, and plan for financial challenges. Not only beneficial for reducing debt in the short term, but debt management programs also provide tools to successfully manage your finances in the future.

If you run into trouble during your program, you can talk to the counseling team to make special arrangements. They may be able to help you delay or adjust your payment without jeopardizing your plan entirely. They are there to be a financial coach and provide assistance to ensure you can graduate from your plan successfully.

Is credit counseling right for me?

Enrolling in a debt management program (DMP) through a credit counseling agency is not a magic cure-all. It won’t work in every situation for every type of debt. Even when it comes to unsecured debt, you need a specific set of circumstances for this to work. Those circumstances are pretty broad but they don’t apply to everyone.

1. You must have at least $5,000 in unsecured debt. If you owe less than that, use a DIY solution.
2. You must have at least some income to make a reduced monthly payment. If you’re unemployed, this solution won’t work until you get a new source of income.
3. Most of your accounts need to be with the original credit issuer and not sent to collections. If your accounts are already with collectors, you may be better off with a settlement. Technically, you might be able to include collections in a DMP but collectors are less likely to agree to these types of repayment terms. In addition, collection accounts have no interest charges, so you lose one of the benefits of counseling (interest rate reduction).
4. Most of your financial challenges should be caused by credit cards. If most of your debts are unpaid medical bills, you don’t get any benefit from the interest rate reduction. In this case, you should work out repayment plans or settlements with the original service providers.

Credit counseling vs debt consolidation

Credit counseling is a service whereas debt consolidation is a debt-reducing strategy. Debt consolidation combines all loans from one or multiple lenders so that the individual only needs to make one monthly payment to the refinancers with a single interest rate, rather than making multiple payments for loans of different rates. There are several options for debt consolidation: balance transfer, debt consolidation loan, or debt management program.  Aside from offering advice, a credit counselor can only enroll you in a debt management program—they do not offer any consolidation services.

Credit counseling vs financial advisor

Credit counselors are certified professionals trained to help individuals manage their debt and improve their financial literacy. They are usually turned to when a person finds themselves in or on the brink of financial difficulty such as being unable to make payments or owing more than they can afford.

Financial advisors are a much broader category of professionals. They don’t require any specific accreditation and can include a wide array of different services and titles including investment advisors, brokers, financial planners, asset managers, or wealth advisors. These professionals focus on financial growth rather than repair. The most similar type of financial advisor to a credit counselor is a financial coach who teaches clients basic financial literacy. However, only a credit counselor can enroll you in a debt management plan and work out better debt repayment terms with your creditors.

How to choose a credit counseling service

Almost all credit counseling services these days are non-profits. However, this status doesn’t mean that any business touting itself as a credit counseling service is legitimate.  There are plenty of cases of businesses presenting themselves as credit counseling agencies when they really aren’t.  That’s why it’s important to know what to look for when choosing a credit counseling organization.

Is the agency accredited?

Look for an agency that’s accredited by a national trade organization like the National Foundation for Credit Counseling (NFCC) or Financial Counseling Association of America (FCAA). If they’re a member of a national trade association, it means they’re compliant with the highest industry standards including [1]:

• Annual agency audits
• Agencies are licensed, bonded, and insured
• Offering a variety of types of consumer support
• Funds are disbursed on behalf of clients at least twice a month
• Clients can make deposits through a variety of methods
• Every client receives counseling
• Clients receive at least a quarterly statement

Are they approved by the DoJ?

The U.S. Department of Justice (DoJ) has a list of credit counseling agencies that are approved to offer services for pre-bankruptcy counseling. Only DoJ-approved credit counseling agencies can provide the counseling required to file personal bankruptcy in the U.S.

Thus, you can look up an agency and see if they’re approved to provide counseling through U.S. bankruptcy courts. If not, then you may want to use the DoJ tool to do a search for an agency in your area that is approved.

No upfront charges

A credit counseling agency that exists to help people (rather than just make money off them) shouldn’t charge any upfront fees without service. Any agency that requires money before giving you more information, providing counseling, or guaranteeing certain results, is a red flag. Also, skip any agencies that charge for educational materials or workshops. Their goal should be to set you up for long-term financial success to avoid debt in the future.

Doesn’t push a one-size-fits-all solution

A credit counseling organization that’s legit and truly has your best interests at heart shouldn’t immediately push you into a debt management plan (which is a service they charge for). Legally, credit counselors are required to tell you about all debt relief options and only recommend what best suits your situation. So if you speak to an agency that instantly tries to push you towards a DMP or doesn’t tell you about any other options, look elsewhere for financial assistance.

Are counselors qualified?

In addition to checking for the validity of the credit counseling agency, look into the qualifications of those you’d be speaking to. How are counselors trained? Are they accredited or certified by a non-affiliated organization like the National Association of Certified Credit Counselors? If not, you just might be speaking to salespeople who make commission after getting you to agree to a certain service.

Look for consumer complaints

Once you’ve found an agency that seemingly checks all the boxes, check with consumer protection sites like the Better Business Bureau (BBB), a local consumer protection agency, or with your state’s Attorney General. Here you can read reviews from past clients to find out whether the company delivers what they say they will and check for any official complaints against them.

How to spot a credit counseling scam

1. Charges upfront fees before they perform any actual service.This is the biggest red flag that a credit counseling or debt relief agency you’re working with isn’t legitimate. According to federal regulations, companies cannot charge fees until they provide some form of actual relief.
2. Guarantee to improve your credit score by a certain number. Although data shows completing a debt management program can improve credit scores in many cases, it’s impossible to guarantee. Results vary based on where you started when you enrolled and what negative penalties you incurred prior to enrollment. Be wary of other false promises that can remove negative marks from your credit report.
3. Advise you to do something illegal. A certified credit counselor will never tell you to try and create a new identity to get away from your old debt. Companies that advise people to get a new Social Security number or Employer Identification Number (EIN) are scams! Counselors won’t even advise that you run or hide from creditors or collectors; they help you find ways to face your challenges directly.
4. Immediately push you into signing up for a specific solution. Nonprofit agencies must advise a client of all available paths to take to become debt-free and only recommend the best solution. If an agency pushes you to enroll in their DMP–or doesn’t even mention the other options available– they’re not following nonprofit counseling organization rules and likely aren’t a reputable credit counseling agency.

contributor

Howard DvorkinAuthor

CPA - Debt.com Chairman & Personal Finance Expert