Why Debt Counseling Services Don’t Work for Most People

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in Credit,debt

Debt Counseling

It’s hard to watch TV for an hour these days without seeing at least one commercial for a debt consolidation service. The ads are convincing; just one call starts you on your way to debt freedom. “Just call us and we’ll take care of it all.”

How comforting that sounds to people drowning in debt! Stressed out, budget stretched beyond reason and not knowing where to turn and these good people are out there waiting to help, bankruptcy not required!

It sounds like a deal made in Heaven but”¦

I’ve actually heard of two or three success stories with these programs, but working in credit over these many years, I must also disclose that I’ve seen hundreds of failures as well. Based on that experience, my recommendation is that you tread very lightly should you decide to pursue this course.

Debt counseling services aren’t get-out-of-jail-free cards, they’re debt repayment programs. What they do is negotiate with your creditors to waive or lower interest charges, or in some cases to reduce principal, but you will be placed into a repayment plan, which will extend over several years and typically includes some type of fee paid to the counseling service and a large initial loan principal payment as a show of good faith.

In theory, the plans should be a win-win; you will eventually get out of debt and your creditors will recover at least most of the money they’ve lent you. However, if you’re over the age of 30, you already know that there’s an enormous gap between theory and reality, and that’s where the problems come in. Four in particular:

1. Money management is the key. The most likely reason you might consider using a debt counseling service is that you can no longer manage the monthly payments on your credit lines. Since the debt counseling service will merely consolidate, not eliminate or even necessarily reduce your overall payment, your short term problem is not solved in any way. You will still be making monthly payments that you won’t be able to afford to pay any more than you could on the original debts.

2. Debt counseling plans are not legal arrangements. This is not to say that they are illegal in any way, only that they are informal in nature and, unlike a Chapter 13 bankruptcy (debt repayment through the courts), they aren’t backed by the force of law. Once you’re in an arrangement, there’s nothing compelling you to complete it, but more importantly from your standpoint, there’s also nothing requiring your creditors to participate either. One or more creditors could opt not to participate in the program, and there have been cases of some participating, but refusing to fully discharge the debt upon completion of the plan. A debt counselor may assure you that such things can’t happen, but I’ve seen it happen.

3. Heavy penalties for failure to follow through. If for any reason you enter such a program and fail to complete it, your credit will be a mess. This is the most frequent occurrence I’ve seen over the past 15 years, and it’s remarkably common (see point # 1 above). Even though your creditors have accepted the payment terms of the plan, the fact is that you still will have defaulted on the original terms of the loans they extended to you. If you renege on the plan at any point, your creditors will report all kinds of ugly things on your credit report, and some of them may do that even if you honor the plan. These are not in any way credit rehabilitation or repair services!

4. Credit-wise, they’re not really much better than bankruptcy. You should know that many lenders treat debt counseling programs just as they do Chapter 13 bankruptcy, which is to say that it will be very difficult for you to get fresh credit during or even for a few years after your plan has been completed. You will enter a plan as an attempt to pay off your creditors rather than default, but the lending world won’t give you too many points for your good intentions. Many won’t ignore the fact that you did in fact default on the original terms of your debt.

It should go without saying that you should not be looking for any new credit until your program has been completed, but cars do break down and emergencies do happen, so be aware of exactly what you are getting into before signing up for any debt counseling services.

Debt counseling is mostly replacing debt with debt, and thus doomed to fail. Ultimately, this is what debt counseling services attempt to do albeit under terms more favorable to you. However, unless you are able to address the root cause of your indebtedness, neither debt counseling nor any other debt type will get you off this treadmill.

Nothing will save you from debt destruction until you get your financial house in order.

Have you ever used or considered using credit counseling services? Do you have any insights that might benefit someone who might be thinking about it?

Kevin At Out of Your RutThis post is from FiscalGeek staff writer: Kevin Mercadante. I’m very excited to have him contributing to the site. You can find out more about him at his own blog OutOfYourRut.com.

( Photo courtesy of alan_cleaver2000 )

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