What Is Credit Counseling?

Credit counseling is a service for people who have problems with unsecured debt like credit card balances or unpaid medical bills. Credit counseling organizations are usually non-profits and offer some or all of these services:

• Budgeting and debt counseling

• Personal finance workshops

• Debt management plans (DMPs)

• Negotiating lower interest rates and/or payments with credit card companies

Credit counselors usually require you to close most or all of your credit cards as a condition of using their services. This is meant to keep you from adding to your debt while you're using their services to improve your financial situation. 

How Does Credit Counseling Work?

Credit counselors can work in offices and meet with clients in-person, arrange credit counseling sessions online, or offer their services over the phone. So what's it like to go through credit counseling?

A typical first session may last 30 to 60 minutes and follow-up meetings may or may not be required. During your meeting with a credit counselor, the goal is to create an accurate picture of your finances so the counselor can help you develop a plan for managing them. Some of the things you'll likely discuss include your:

• Income and assets

• Budget and monthly expenses

• Debts

• Financial goals

You may be asked to prepare certain documents before your meeting with the credit counselor, including pay stubs, tax forms, bank statements or credit card statements. The credit counseling agency may ask your permission to pull your credit reports. This can help them better understand your overall financial situation. 

Is Credit Counseling Worth It?

For some, turning to credit counseling can be the right answer, but it's not for everyone. Whether it's right for you depends on several factors, including how much you can afford to put toward your debt each month.

A study by researchers at Ohio State University found that people who got credit counseling paid down their balances faster. This was true compared to those who did not get counseling. This shows that credit counseling works. It helps people manage and reduce their debt.

However, the study also found that this did not necessarily lead to higher credit scores. This may be because credit counseling enrollees are usually required to close their accounts. This can cause a temporary score drop. Still, the benefits of reducing debt and learning financial management last a long time. They are greater than the short-term impact on credit scores.

Here are some other points to consider about credit counseling and a debt management plan: 

Benefits of Credit Counseling:

• Provides professional guidance: When you take part in credit counseling, you work with trained credit counselors. These counselors help you negotiate debt with your creditors and help you come up with a realistic monthly budget. In other words, credit counseling provides you with a roadmap out of debt. 

• Personalized Debt Management Plans: Everyone's roadmap out of debt is slightly different. It's all based on a personalized debt plan (DMP) that combines your current debts into one payment. While a counselor works to ensure that your payment plan is manageable, the monthly payment is often too high and participants drop out of the program before they've accomplished their goal of becoming debt-free. It's important to make sure that you can afford the monthly payment before signing on. 

• Long-term financial health: Credit counseling can help you learn more about your finances. For example, credit counselors are often able to work with creditors to get interest rates lowered and fees waived. Once you understand the importance of landing a lower interest rate, it will help inform all your borrowing decisions going forward. You'll also learn how to budget, save for emergencies, and avoid unnecessary debt. 

• Emotional relief: It's impossible to deny the emotional impact of debt. Having a professional there to help can provide relief by reducing stress and helping you feel more in control of your finances.

• Increased financial confidence: Studies have indicated that people who complete credit counseling tend to feel more confident about their ability to manage their finances. This makes sense when you factor in the "before" and "after" perspective they gain. If you're in debt, you know what it's like to be on that side of the ball. Once you've gone through credit counseling, you not only understand how you got there, but you also know what it takes to get out of debt and stay out of debt. 

Potential Drawbacks of Credit Counseling

• Temporary credit score reduction: Joining a DMP might require closing some or all of your credit card accounts. This can affect your credit use ratio and, thus, your credit score. However, before you assume your credit score will take a hit, it's important to understand that your specific situation may not require you to close any credit card accounts. 

• Fees associated with the service: Although many nonprofit organizations offer free initial  consultations, there may be setup and monthly maintenance fees that add up over time. It's important to understand the scope of fees before entering into a DMP.

• Limited creditor participation: It would be great if all creditors were willing to work with DMPs but that is not the case. Let's say you need help with five separate debts but only three of your creditors will sign on. That leaves you with two debts to work out on your own. 

• Commitment required: DMPs are like joining a gym or getting married. It's not enough to sign your name to the gym contract or marriage license. You have to put in the work to ensure that it's a success. In the case of a DMP, you'll need to follow your counselor's advice, stick with a budget, and make all payments as agreed. Without this commitment, you may not fully realize the benefits of the program. 

While entering a DMP may be the best possible move for one person, it's not a one-size-fits-all solution. If you're struggling alone to pay your debts, learning how a DMP would work in your specific situation may be a worthwhile investment in your future.

What Services Do Credit Counselors Perform?

Credit counselors can offer a variety of services to help you get on track financially. Some of the things credit counselors can do include:

• Helping you to analyze your spending and look for ways to cut expenses

• Creating a workable budget, based on your income and spending

• Developing a strategy for managing and paying down your debt

• Discussing ways to improve your credit rating

Your credit counselor will review your financial information. Next, your counselor recommends an approach to your debt. For example, if you're looking for a way to streamline your monthly payments your credit counselor might suggest a Debt Management Plan (DMP). 

Credit counselors contact your creditors and may be able to reduce your monthly payment, negotiate a lower interest rate, or get penalties waived. They then come up with a monthly payment, which you pay into your plan. This payment may be more affordable to you, or it might help you repay your debt faster. The counseling service distributes your monthly payment among your creditors. 

Keep in mind that this type of credit counseling is a little different from pre-bankruptcy credit counseling. If you file for Chapter 7 or Chapter 13 bankruptcy, you're required to complete credit counseling and debtor education with an approved agency.

How Much Does Credit Counseling Cost?

You might be wondering if there's such a thing as free credit counseling, especially if your budget is already tight. The good news is that nonprofit credit counselors may not charge any fees at all for your initial counseling session. Nonprofit credit counseling organizations are generally more concerned with helping people to get their finances on track versus collecting fees. 

Does that mean you won't pay any fees at all for credit counseling? Not necessarily. 

If you're enrolled in a debt management plan, for instance, your credit counselor may charge an initial setup fee and/or a monthly processing fee. These fees can be limited by state law. In New Jersey, for example, credit counselors can charge a maximum setup fee of $40 and the monthly fee is also capped at $40. If you're considering a DMP, it's important to read through the fees first to make sure you know what you'll pay. 

Does Credit Counseling Hurt Your Credit Score?

Simply meeting with a credit counselor shouldn't impact your credit score at all, unless the credit counseling agency performs a hard check of your credit reports. Hard credit inquiries can show up on your credit history and knock a few points off your scores. 

However, closing accounts, which is generally a credit counseling and a DMP requirement, can cause your scores to temporarily drop. It reduces the average age of accounts, which makes up 15% of credit scores. 

The good news is that making payments to the plan on time each month adds good payment history to your credit report. Payment history accounts for 35% of your FICO credit scores. And as balances fall, so does your credit utilization ratio (the portion of your credit lines that you borrow against). Credit utilization makes up 30% of your credit score. The Ohio State study found that over time, counseled consumers’ credit scores did increase. 

Where to Find a Credit Counselor

If you're ready to find a credit counselor, there are a few places you can look for recommendations. Some of the options you might consider include:

• National Foundation for Consumer Credit Counseling (NFCC)

• Financial Counseling Association of America (FCAA)

• United States Trustee Program (if you need pre-bankruptcy credit counseling)

You can use these sites to find nonprofit credit counselors that offer services in your local area. Once you've got a list of credit counseling agencies you're considering, the next step is researching them individually.

You can check with your state attorney general's office or your state consumer protection bureau to see if any complaints have been filed against the company. Next, reach out to credit counseling agencies to learn more about their services. You can also check consumer review sites, including the Better Business Bureau (BBB), for any negative reviews.  

Here are some key questions to ask when vetting credit counselors:

• What services do you provide?

• How is credit counseling offered? (i.e. will you meet in-person, online, by phone, etc.)

• Are there any fees involved? What are they?

• Are fees waived for people who can't afford to pay?

• Do you offer free educational resources? 

• What certifications or accreditations do you hold? 

Asking these kinds of questions can give you a better idea of what you can expect when working with a credit counselor. If you know someone who's gone through credit counseling, you can also ask them for their perspective. They may be able to offer insight into a particular credit counseling agency that's on your shortlist. 

What Credit Counseling Can’t Do

The most important thing to know about credit counseling is that it's not a quick fix and it won't necessarily help everyone. Credit counseling only works if you can afford the monthly payments and you're committed to changing the financial habits that led you into debt in the first place. 

Credit counseling does not reduce your outstanding balances. Those who can’t be helped by credit counseling or debt management may need to consider stronger remedies like debt settlement. You may pay a fee for debt settlement services if you're using a debt relief company. But compared to filing bankruptcy, that could be a more attractive option.