With a perfect storm of falling housing values, rising loan defaults and a slowing economy, more folks are struggling to manage their debts, and more will turn to companies that sell credit repair and credit counseling services.
Many of these companies aren't regulated by federal law, so anyone can open a credit counseling business. As a result, the services provided can vary widely from one company to the next.
The trick is to not get confused by the similar names and similar claims.
If you are struggling with debt, a legitimate credit counseling company can help. But a bad one can do more damage.
Here's a guide to help you know what to look for.
A Few Bad Apples
Many credit counseling companies are set up as non-profit corporations. This can create an appearance that these companies exist solely to look out for you -- that they exist to provide a public service. This nonprofit status enables them to gain a marketing edge by creating an image that implies, "We're the good guys. We're a non-profit credit counseling company!"
Unfortunately, in some cases, the services provided come with a hidden agenda and lots of hidden fees. The most famous example was Ameridebt, which agreed to shut down its debt management operation in a settlement with the Federal Trade Commission, which had charged that Ameridebt deceived consumers into paying at least $170 million in hidden fees when it claimed to be a nonprofit that would teach people to manage their finances for no upfront fee.
Credit Repair Shops
These outfits claim that, for a fee, they'll clean up your credit report so you can get another loan, get a better mortgage, better insurance rates, or even a job. Essentially, they offer to manipulate or even manufacture credit report information about you that creates the appearance that you have been a responsible consumer of credit. Often the promise includes removing all late payments and other derogatory information from your credit report.
Of course, to perform this service -- who wouldn't want to start over with a "clean slate" when it comes to your credit reports -- you simply have to pay a few thousand dollars and agree to a few credit schemes.
Tip Off to the Rip Off
One of the credit repair schemes is to "create a new you" by applying for and obtaining an Employer Identification Number for you to use instead of your Social Security Number on new credit applications. Another trick is to use "piggybacking," which is where you are added as an authorized user on another individual's credit account, which of course has a good history of timely payments, the objective being that the other person's account with the good history appears on your credit report, which increases your credit score.
What you should know is this: Aside from being dishonest, these scams are illegal. It is a federal crime to lie on a loan application or obtain and use an Employee ID number under false pretenses. And the claims to remove negative information from your credit report? No one can legally remove accurate and timely negative information from your credit report.
Credit Counseling Services
Not to be associated with credit repair shops, consumer credit counseling firms offer several different and legitimate services. First, education and debt-management counseling by trained professionals who can meet with you in person, over the phone, or online to help you review your debts, set a budget, and help you develop a plan to pay down that They can also help you learn new money money-management skills to keep you from getting overwhelmed with debt again.
The second service they can provide is a Debt Management Plan, or DMP. Essentially, what they do is arrange for you to make one payment to them and then they take over the administration of splitting up your single payment and doling it out to your various unsecured debts in accordance with terms that have been agreed to by your creditors.
Of course, for this they keep some of your money every month as a fee for their DMP services.
If you sign up for a DMP, you authorize the credit counseling service to intervene with creditors on your behalf. You send the credit counseling company a check every month, and they parcel that out to pay off your debts for you.
When using a DMP, the credit counseling firm uses its prearranged deals with various creditors, in which they have negotiated some or all of the following terms in regards to the debt you owe:
1) Lower your credit card interest rates
2) Eliminate late fees or other fees that have accumulated on your account
3) "Re-age" your credit accounts by re-categorizing them as "current" instead of being "late".
Some studies suggest that more people should turn to these services before their debt becomes an unmanageable problem. Even after debt becomes a problem, this education and debt management can be helpful to people struggling with their debt.
In fact, the US Bankruptcy Code now requires all individuals who file for bankruptcy relief to receive a briefing within 180 days before filing that outlines credit counseling and provides assistance in performing a budget analysis. These services must be provided by a nonprofit budget and credit counseling agency this is approved by the United States Trustee Program, a part of the Dept of Justice. For a list of approved credit counseling agencies, log on to firstname.lastname@example.org.
Costly, Problematic DMPs
There are some consumer reports that some credit counseling firms are not offering debt management advice and instead are pushing consumers into their main product -- DMPs.
If you are in serious debt trouble, a DMP sounds like a good thing, right? Not if they don't deliver what they promise. Consider the following message received from a consumer who complained about her experience with a DMP:
"I got into debt early and tried to fix my payment problems with credit counseling. The hope was that they would lower my interest rate and I would have only one payment to make. The only thing they did was lower my credit score and add more late fees. The counseling service wouldn't pay on my due date because they only paid once a month on their payment schedule…now I have more debt."
Better Business Bureau reports suggest that complaints against credit counseling agencies are on the rise. A Consumer Federation of America study found problems exactly like the one explained above. Some of the biggest problems include such behavior as not disclosing fees to customers, not paying debt accounts on time, and signing up customers for DMPs without their approval.
In a recent BBB Consumer Alert in Michigan, consumers allege that a company named "Clear Your Debt LLC" tells folks they are merely filling out applications for the company to review whether the individual is a qualified candidate for its services, then makes debits of its fees from their checking accounts without their consent or knowledge.
A Pass/Fail Test
If the credit counseling service you are considering looking into flunks any of the following tests, you should avoid it. These are the top three "red flags" that the firm could do more harm than good:
1) Flunk the 30-Minute Test: Before offering you any advice, the credit counselor should spend at least 30 minutes talking to you about your finances. A truly effective counseling session should last between 30 and 90 minutes. If, after less than 30 minutes, they are "advising" you to enroll in their debt management plan, go elsewhere.
2) Push you into a DMP: Not everyone who visits a counseling service needs to be enrolled in a DMP. The debt counselor should talk to you about whether a debt management plan is appropriate for you, rather than assume it is appropriate. The truth is these companies make money when you enroll in a DMP. Many creditors give them a percentage of what you pay toward your debt. If a credit counseling company is pushing you into a DMP, you can assume it cares more about its own bottom line than yours.
3) Charge High Fees: Most services charge a set-up fee to begin a DMP and a monthly fee to administer the program. However, if a firm charges more than $75 as a set-up fee, and monthly administration fees that exceed $40, go elsewhere.
What You Need to Know
So here's the big question: Is it worthwhile for anyone to use a credit counseling service?
If you are having a problem managing your debt payments, specifically credit card debt payments, and this is causing you to be late or miss payments, incurring high interest and additional fees on multiple accounts, then you should think about calling several credit counseling companies and seriously considering their services.
Before you decide to work with a credit counseling service, do the following:
If you decide to turn to one of these companies for help, you have to stay involved in your financial affairs.
Before you enroll into a Debt Management Program, you need to call your creditors and make sure that they have agreed to the terms of your DMP; you have to make sure your bills are being paid on time.
If you enroll in a DMP, you need to know how this will show up on your credit report and how it can affect your credit score. Next to each credit account enrolled in a Credit Counseling Debt Management Program, there will be a comment that states "MANAGED BY CREDIT COUNSELING COMPANY" or something similar.
It is important to know this because, if you later apply for another loan -- such as a car loan or mortgage -- the lender will see this and may ask how you got into the situation and what you are doing differently now to avoid it in the future. And while using a credit counseling service does not directly affect your credit score, having your debt accounts enrolled in a DMP may lower it for awhile.