You know what credit and counseling are, but what is credit counseling (sometimes called consumer credit counseling)? It’s not for everyone, but it’s a service that involves a deep dive into your finances to determine the best way forward out of crippling debt. Most credit counseling providers offer customized plans, for an additional fee, that combine your debts into a single payment program.
The average American consumer had $51,900 of debt in the second quarter of 2020, according to a recent Federal Reserve Bank of New York report. Much of this is tied up in home loans, but nearly one-third of U.S. household debt consists of credit cards, student loans, car loans, personal loans, and other—mostly unsecured—forms of debt. If you’re unable to pay down balances like these each month, it may be time to consider credit counseling or other forms of debt relief.
Is credit counseling right for you? It depends. It’s not the only way to get out debt and it isn’t ideal for every situation. Here, we give you the details on what credit counseling entails and review a few other debt relief methods, so you can decide for yourself.
What is credit counseling and how does it work?
Credit counseling won’t erase your debts or lower the amount you owe. But for those who are best suited to this process, it can help you create and stick to a budget; control your spending; better understand interest rates, improve your financial literacy; and, if you opt for a debt management program (or DMP), simplify your debt payments.
Consumer credit counseling organizations typically provide three main types of services:
- A budget is a financial plan that takes your income, assets, debts, and financial goals into account. Budgets give you the visibility you need to best manage your finances.
- Debt counseling. Credit counselors can help you determine the best ways to approach any particular type of debt, whether it’s student loans, credit cards, or housing expenses. They also work with people who file for bankruptcy.
- Debt management programs. DMPs are structured, customized plans to help you simplify your unstructured debt payments (often into one single payment). Credit counselors also may negotiate lower interest rates with your creditors.
The goal of credit counseling is to provide more clarity into your finances, improve your financial literacy, and help you develop better financial habits with the goal of reducing or eliminating debt. Consumer credit counseling organizations, which are nonprofit, charge a fee for basic services and additional fees if you choose to set up a DMP.
What are DMPs and how do they work?
Debt management programs (DMPs) are customized debt repayment plans, brokered between the credit counseling agency and your creditors. The lower interest rates they’re able to negotiate (typically through pre-arranged agreements) are referred to as a “concession rate.” The DMP is a legally binding agreement that you will make a certain payment each month, typically at a lower interest rate, until the debt is paid off (two to five years on average).
The consumer pays an initial set-up fee and monthly payments, while the credit counseling agency collects “fair share” payments from the creditors, in accordance with their agreements. You’ll want to steer clear of agencies that have hidden fees, ask for “voluntary” contributions on top of the usual fees, charge for educational services, or ask for personal details before they fully explain their services.
How to determine whether credit counseling is right for you
Credit counseling can be an effective route for getting a handle on your debts. Before you sign up with a consumer credit counseling service or enroll in a DMP, however, you should ask yourself:
- Am I able to make my monthly minimum loan payments?
- Could I possibly pay even more than the minimum monthly payments?
- Am I current on at least one of my credit card accounts (meaning there is no past due balance)?
It may be the right choice if you answered “yes” to all of these questions. If you’re having difficulty making minimum payments, don’t have enough income to pay more than the minimums, and have maxed out your credit cards, you may need to pursue other measures.
Alternatives to credit counseling
If you’re not experiencing a financial hardship, you may be able to get out of debt yourself by auditing your finances, coming up with a plan, and sticking to it. Other options include the following.
- Home equity. If you have equity in your home, you may be able to use some of it to pay off debt, either through a cash-out refinance loan or a home equity line of credit (HELOC). The risk, however, is you may lose your home if you default.
- Debt consolidation. If you’re able to get a lower interest rate than what you already have, a debt consolidation loan or a low-interest balance transfer credit card can help reduce debt. Keep in mind, however, that the low rates (sometimes 0%) of credit transfer cards only last for a year or so.
- This should be considered your last resort, as bankruptcy may damage your credit for several years, repayment plan terms can be severe, and you may lose your home and/or other assets.
- Debt settlement. In a debt settlement program like the one at Freedom Debt Relief, you stop paying your creditors, putting that money into a dedicated account—which you fully control—instead. The debt settlement company negotiates with your creditors to lower the amount of debt you owe. Once they reach a settlement, you pay it off with the funds you deposited in your account. There might be a temporary drop in your credit score and your creditors might choose to take legal action for non-payment. However, for those with a financial hardship and a great deal of debt, these programs can lower the total amount of debt owed, teach financial skills, assist with legal actions, and help resolve debt.
Which is the right option? Tapping into your home equity or pursuing debt consolidation is a good option for certain situations. If you’re deep in debt and experiencing financial hardship (job loss, health emergency, divorce, etc.), then your best options may be either bankruptcy or debt settlement. If you qualify for Chapter 13 bankruptcy, however, you may want to consider debt relief first.*
Bankruptcy can be more expensive, take longer to complete, and may have a more lasting impact on your credit score. Debt settlement has its share of risks, too, but it’s an option that may actually lower the original amount of debt you owe.
Understand your needs, and your options, before you commit
Credit counseling is just one method for getting a handle on your debt, but not the only one and perhaps not the right solution for you. If you’re considering your options, speak to one of our Certified Debt Consultants. They’ll go over your financial situation with you and help you determine whether Freedom Debt Relief’s debt relief program makes sense in your situation. The consultation is free—and you can get started right here.
- How to Create a Credit Card Payoff Plan (Freedom Debt Relief)
- What is Credit Counseling? (Consumer Financial Protection Bureau)
- Consumer Credit Counseling Agencies: Pros & Cons (Freedom Debt Relief)
- Choosing a Credit Counselor (Federal Trade Commission)
- Unemployed? Here’s How to Keep Managing Your Credit Card Debt (Freedom Debt Relief)
*Disclaimer: Freedom Debt Relief does not assume your debts, make monthly payments to creditors or provide tax, bankruptcy, accounting or legal advice or credit repair services. Our service is not available in all states and our fees may vary from state to state. The use of debt settlement services will likely adversely affect your creditworthiness, may result in you being subject to collections or being sued by creditors or collectors and may increase the outstanding balances of your enrolled accounts due to the accrual of fees and interest. However, negotiated settlements we obtain on your behalf resolve the entire account, including all accrued fees and interest. C.P.D. Reg. No. T.S. 12-03825.