Anyone watching television recently can attest to the myriad of advertisements by Credit Counseling Agencies touting services that promise to reduce credit card debt, and keep people out of bankruptcy. Credit Counseling Agencies have multiplied rapidly as a result of American's increased credit card use (or misuse) over the past twenty years. With bankruptcy filings at record levels primarily as a result of overwhelming credit card debt, there is no doubt there is a growing market of people in need of debt relief. But is credit counseling an alternative to bankruptcy? Many in Congress seem to think so. One key component of the new bankruptcy reform legislation consists of requiring anyone filing bankruptcy, first to obtain certification that they consulted with a Credit Counseling Agency. 

Many don't understand the mechanics of credit counseling, including lawmakers wishing to mandate these organizations as a bankruptcy alternative. To begin, one must understand what credit counseling does and what it doesn't do. One common misconception is that credit counseling can partially eliminate debt. In fact, most Lenders are unwilling to even reduce the high interest on monthly payments, yet alone reduce the principle. Credit Counseling Agencies, moreover, may be late in applying payments to Lenders, resulting in the imposition of added late fees. It begs the question: if a consumer's financial troubles stem from their inability to stay current on installment payments, how then does credit counseling provide them any relief? One answer is that it doesn't! 

Consider that the Credit Counseling Agency and the Lender have a symbiotic relationship. The Counseling Agency collects payments from delinquent Borrowers participating in it's program, and then allots those payments to the respective Lenders to whom the Borrowers owe money. The Lender, in return, “contributes” to the Counseling Agency a percentage of the funds recovered for the Lender's benefit. The Counseling Agency clearly has an incentive to draft as many program participants as possible. Simply, the more participants, the more contributions the Counseling Agency receives, and contributions are their lifeblood. Lenders, quite reasonably, don't want to accept payments through Counseling Agencies from those Borrowers still current on their obligations. A Borrower who makes timely payments is a good customer, and Lenders refuse to pay contributions for payments collected from their good customers. The Counseling Agencies thus require a Borrower to be at least three months delinquent before becoming eligible for their credit counseling program. It doesn't matter if the Borrower is incapable of ever retiring a suffocating principle balance, as long as the Borrower can maintain the minimum monthly interest payments, credit counseling does not help. In fact, the paradigm of the Lender's best customer is a Borrower who pays interest on large balances indefinitely -- and credit counseling won't be allowed to disturb that relationship.

Recently, the Consumer Law Center of America released a lengthy report, which can be downloaded from their website at www.consumerlaw.org, and which details some troubling business practices of Credit Counseling Agencies. Problems included the abuse of non-profit status; misrepresenting the effectiveness of their services; and fee gouging to name a few.  

There are other draw-backs, not often discussed by credit counselors, such as credit counseling participation being divulged on the Borrower's credit report for seven years; the same length as bankruptcy. Lenders, moreover, must voluntarily choose to participate in the plan, and some Lenders may not accept the Agency’s proposal. It is reported that some Lenders will agree to participate, but later resume independent collection outside of the plan, or demand higher payments than originally agreed upon; a tactic that often leads to the Borrower to the steps of Bankruptcy Court. 

Not all Credit Counselors are bad, however consumers must be aware that a conflict of interest does exist. Many Counseling Agencies flout their non-profit corporate tax status as a means to convey legitimacy. What should now be clear is that Credit Counseling Agencies, despite their corporate tax status, are not designed to help people overburdened with debt so much as they are designed to collect debt from those already in default. In fact, it would be correct to characterize Counseling Agencies as voluntary Collection Agencies. The modus of Credit Counseling Agencies and Collection Agencies is essentially the same. Both obtain revenue by receiving a percentage of the amount collected from overdue Borrowers. 

Most Borrowers are frightened by the thought of filing bankruptcy, which makes them susceptible to any message that promises an alternative. Many will attempt credit counseling, only later discovering they cannot afford to maintain the required payments over the plan's duration. Those people will likely file bankruptcy at some point. Maybe they should have filed earlier, since going through credit counseling didn't work as planned. They only succeeded in paying-out a few more of their scarce dollars to Mastercard and Visa before finally succumbing to their financial pressures. 

It may be objectionable that Borrowers are now being legislated into treating credit counseling as an alternative to bankruptcy, especially when Lenders know differently. If the consumer ends up filing bankruptcy after credit counseling, then the consumer didn't benefit from credit counseling -- but the Lenders did! Lenders recovered funds that otherwise may not have been collected had the consumer opted to file bankruptcy immediately. Payments collected from Counseling Agencies prior to a Borrower's bankruptcy may only be a small portion of a Lender's outstanding debt, but can still add up to a significant amount of revenue for Lenders when viewed in the aggregate. 

Does credit counseling help some? Possibly, but Counseling Agencies are reticent to supply data to confirm the effectiveness of their services. It would be helpful to know, for instance, how many participants successfully complete their credit counseling plan, or how much money is collected from Borrowers prior to a withdrawal from their plan. Since this information is not disclosed, valid comparisons are lacking. Perhaps those viewing credit counseling as an alternative to bankruptcy may think differently if the data proves that only a small percentage of people actually complete a counseling program, or if most eventually drop-out of the program and file bankruptcy.

However people may feel about bankruptcy, one thing is clear: credit counseling should not be viewed as an alternative in every case. Credit counseling, by its nature, cannot logically be a panacea. It may be helpful to some Borrowers, although no data has been provided. More likely it helps Lenders far more than Borrowers. It should raise concerns that program recidivism rates are not disclosed, especially now that a credit counseling briefing is a new requirement for anyone who files bankruptcy after October 17, 2005.  

If you are contemplating bankruptcy, by law you must now meet with a credit counselor first.  I urge you to be credit counseling cautious.  Be mindful that credit counselors may be well meaning, but they are not attorneys who can give legal advice or who are subject to a professional code of ethics. There is an inherent conflict of interest that must be considered when meeting with credit counselors.  If you have questions about the proposed counseling plan provided to you, please contact me at your convenience.

--Barry Sternberg