How Credit Counseling Can Help You

When your debt feels overwhelming, certified consumer credit counselors can be the champions in your corner.

Initial consultations are typically free, though some services come with setup and monthly fees. Counselors provide three main services:

• They help you understand how you got where you are. Counselors survey your finances from top to bottom to help you understand your situation, spending habits and problem areas.
• They show you a financial path forward. Counselors offer solutions to your financial pain points while helping you plan for long-term goals, such as paying off student loans or buying a house.
• They help you deal with your debt. Counselors can craft a debt management plan that gives you financial breathing room and a clear path toward living debt-free. If you can’t realistically pay your debts, counselors provide the consultation that is mandatory before filing for bankruptcy.

Credit counseling is not a magic wand to wave away your debts, however. Even with the help of an experienced counselor, paying off a large amount of debt takes determination and, often, years.

And if you succeed at wiping out your debt, you’ll still have to tackle the underlying problems. That means learning to budget and live off what you earn.

Credit counseling vs. other types of debt relief

Some people take a do-it-yourself approach to paying down debts, through a combination of better budgeting, extra earnings and debt consolidation. (See “How to Pay Off Debt.”)

Others may decide they can’t do it on their own. Typically they consider three options:

• Debt management, in which a credit counselor takes over bill payments and helps negotiate lower interest rates.
• Debt settlement, in which a third-party company collects your payments and, when enough money has accumulated, makes lump-sum settlement offers to your creditors.
• Bankruptcy, which protects you from collections and lawsuits when you are unable to pay your bills.

We strongly recommend that you compare these options for debt relief carefully before proceeding with any of them.

Bankruptcy offers the most immediate relief, but it tanks your credit for many years to come and isn’t an option for everyone. Even so, NerdWallet columnist Liz Weston advises you to visit a bankruptcy attorney before you consult a credit counselor.

“If your unsecured debts, like credit cards, personal loans and medical bills, can’t be repaid in five years, you may be better off filing for bankruptcy,” Weston says.

With debt settlement, it can take months or even years to accumulate enough money with the third-party provider to begin making lump-sum offers to creditors, severely damaging your credit as the unpaid bills stack up. Creditors can sue you, resulting in wage garnishment and bank liens.

Debt management plans, on the other hand, offer a way to pay every dollar you owe with help from reduced interest rates and advice from an expert, and they are much kinder to your credit.

Debt management plans can reduce your payments

In a debt management plan, counselors negotiate with creditors on your behalf to reduce interest rates, establish a new payment plan, or waive fees and penalties — or all three. You send money to the credit counseling agency; it pays your creditors.

Once you’ve made some regular payments, counselors may also be able to bring your delinquent accounts back into current status on your credit report, a process known as “re-aging.”

Because counselors already have relationships with creditors (and some even have agreed-upon interest rates), they are more likely to get results than if you tried to do it yourself. Reduced interest rates can mean your total debt payments drop. For example, Massachusetts-based Cambridge Credit Counseling’s data on its 2013 enrollees show interest rates cut by more than half. At 22% interest, erasing a $20,000 debt in five years requires monthly payments of $552; at 11% interest, the payments would be $435.

What is it like to work with a credit counselor?

An honest relationship with your credit counselor makes a difference.

“Joy is like a sister to me,” Kristine Constable of Illinois says of her consumer credit counselor, Joy Gaddis, from Clearpoint Credit Counseling Solutions.

On Gaddis’ advice, Constable went on a debt management program. She closed six lines of credit; her counselor negotiated with creditors to reduce Constable’s interest rates and presented a plan to pay off her debt.

Four years ago, Constable had $76,000 in debt and a credit score of 633. Through the debt management program, Constable has paid her debt down to $7,000 and raised her credit score to 788.

Without the help of her credit counselor, it would have taken Constable 35 years to pay off her debt, and she would have paid an additional $270,000 in interest, according to Gaddis. Constable now expects to be entirely debt-free by the end of 2016.

“It’s such a feeling of freedom to get off the hamster wheel and make progress on your debt,” Constable says. “You can dream again after you have your money back in your control.”

Your credit counselor may determine that a debt management program isn’t right for you. In fact, only 22% of clients enroll in such a program, according to data from Cambridge Credit Counseling. The majority of their clients simply needed an answer to a specific question or budgeting advice.

How much counseling costs

You won’t pay anything to simply meet with a credit counselor to discuss your situation, budgeting or financial planning decisions.

However, if you sign up for a debt management plan, there is typically a one-time enrollment fee that is capped at $75 for nonprofit agencies that are members of the National Foundation for Credit Counseling, one of the organizations that certifies counselors.

There is also a monthly administrative fee that can be up to $50, though the average across NFCC agencies was $28 in 2015. This fee covers the whole of the program, no matter how many lines of credit you include. These costs vary depending on your situation. In many cases, the enrollment fee and monthly fees are reduced or waived because of a client’s financial hardship.

Credit counseling agencies also receive money from creditors, known as “fair share fees.” Credit card companies pay counseling agencies based on the amount they receive from the consumer. The IRS mandates that credit counseling agencies can receive no more than 50% of their funding in this way.

Counselors also provide the consultations and completion certificates needed to file and complete bankruptcy.

Expect to pay $50 to $100 for an approved prebankruptcy consultation. If you decide to file a bankruptcy petition, you’ll receive mandatory financial education classes before the debts are discharged.

How counseling affects your credit

Simply meeting with a credit counselor — no matter how many times — will not have an impact on your credit.

If you sign up for a debt management program, your creditors may note on your credit report that you are enrolled in one, but that information does not affect your score by itself. You may see a temporary decline in your credit scores if accounts are closed.

In the long term, your credit score is likely to improve if you follow the advice of a credit counselor — especially if you make your payments on time, since on-time payments account for one-third of your credit score.

If you don’t make payments, you could wind up with a large remaining debt and damaged credit to boot.

Nearly 60% of consumers don’t complete their debt management plans, according to data gathered by Cambridge Credit Counseling. Some of those people may wind up in bankruptcy court after years of payments through debt management plans.

Next steps

A credit counselor can help you plan a strategy, but in the end, only you have to power to get yourself out of debt.

While a debt management plan may not be right for you, the financial education services offered by credit counseling agencies can give you the tools you need to make the most of your financial situation.

But make sure you’re comfortable with your counselor, and ask what’s required of you, how fees are calculated and what to expect in the years ahead.

Sean Pyles is a staff writer at NerdWallet, a personal finance website. Email: spyles@nerdwallet.com.

This article was updated. It was originally published Jan. 9, 2015.