Why Debt Counseling Services Don’t Work for Most People


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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Norman 2010/04/14 at 9:58 am

Credit Counseling agencies are not to be confused with Debt Settlement companies. There is a big difference between Debt Settlement companies and not-for-profit Credit Counseling agencies. Debt Settlement companies take your money up-front. Sometimes they will get their fee first, then keep your money until they have enough in your account to offer a settlement to your creditors (in the meantime you could get sued by your creditors). On the other hand, most not-for-profits (501c3) credit counseling agencies who are members of the National Foundation for Credit Counseling (NFCC) do not charge any fee for credit counseling and budgeting. They also offer a debt management plan where (as you state) the creditor will offer consessions to the debtor for entering a debt management plan (DMP). The agency usually changes a management fee of around $25 per month while on the DMP. There is no consolidation of the debt involved and the client volunteers to enter the program because they want to pay off all their creditors. They make a monthly payment to the agency, then the agency disburses the money to all the client’s creditors. In exchange for going on the managed repayment program, most major creditors will offer the consessions which normally lowers the monthly layout to the consumer. Usually over the required repayment schedule of 3 to 5 years, the amount of interest savings and fee savings can be quite substantial allowing the debtor to pay off all their debt to the creditor rather than filing bankruptcy. A good majority of debtors going on a DMP already have poor credit histories (late payments, credit overlimits) when entering a program. So the “harm” has already been done.

kevin 2010/04/14 at 10:25 am

Norman – thanks for pointing out that difference! The non-profits are more reputable and “better deals” financially speaking. However, my experience has been that people fail in them at nearly the same frequency as with the debt settlement companies, for all the same reasons listed in the post.

What ever plan anyone would take on, they have to be fully prepared to follow through. There’s no magic in any of them, and all rely almost entirely on the efforts and compliance of the debtor.

Budgeting in the Fun Stuff 2010/04/14 at 11:36 am

Thankfully, we’ve never needed to look into these. It sounds like something a person could do for themselves without the fee, right? I could call and negotiate a debt repayment plan with a credit card company myself, right?

kevin 2010/04/14 at 2:32 pm

Yes and no. You’d have to be a strong negotiator (and have a strong telephone manner) that some are and some aren’t. Let’s say that a lot of people could do it, or might know someone who can.

If you do try it on your own, it’s absolutely critical that you get any agreements in writing. A creditor could accept funds under a verbal agreement, then dissavow it after the fact.

And of course, once you do get written agreements, it’s important to follow through. This is where most of these agreements–including those negotitated by a counselor–fall apart. A settlement can’t be a stall techique to hold off your creditors while you await a miracle. It has to have a workable plan.

Len Penzo 2010/04/14 at 12:31 pm

Gosh, Kevin.

For the most part, I think these services are a lot like the equivalent of (and sorry in advance for the tired cliche) shuffling deck chairs on the Titanic.

Assuming you aren’t in so deep that you have no hope of ever fixing the problem yourself, it almost sounds like Chapter 13 would be a better option. Your credit gets ruined but at least you get a bit more protection under the law.

All the best,

Len Penzo dot Com

kevin 2010/04/14 at 2:37 pm

Well put Len! I agree, Ch 13 would be better. But debtors do fail to complete that as well. Up until the bankruptcy reform act of 2005, many could use the Ch 7 conversion if they couldn’t complete the 13, but that’s not so easy any more.

I think it comes down to what so many write about in personal finance blogs, that you need to cut expenses and expand income. No repayment plan of any type can work otherwise.

Kerry 2010/04/14 at 2:27 pm

Before we got married my husband had about $20k in credit card debt, etc. He started a debt counseling program about 9 months before we got married and he just paid it all off in January (~ 18 months). I agreeded to support him financially while he did it (he quit his job to go back to college for his B.S., as well) so all of his $ he was making was going towards the debt. It took a lot of strength and commitment, but his credit score is already 100 points higher than it was when he started. I know that it’s just a number and they look at a lot more, but still. I’m proud of him.

kevin 2010/04/14 at 2:39 pm

Kerry, you should be proud of him, and of yourself for your support. You and your husband did it by fully committing to it, which is the only way it works.

James 2010/04/16 at 9:41 am

its like the IRS if you are in serious trouble, if you open up lines of communication with them and let them know you want to pay off your debt off they are very willing to work a deal with you.

it really comes down to, do you want to make it happen if so, put in the time.

Katie 2010/04/17 at 4:36 am

I did a credit counseling program several years ago. I owed more on credit cards than I was making in a year, and I needed a way to dig out of the hole. The credit counseling agency did negotiate reduced interest rates on many of my cards, but there was actually a more important aspect of the program for me: it automated my repayment. A set amount per month was going out of my bank account no matter what I did, so I had to be sure the money was there. Also, a set amount went to the payment of the credit cards every month, on time. There was no forgetting on my part, and no only paying the minimum some months so I’d have more cash.

Some people can do this for themselves, for sure. But some of us need the structure of “X amount is getting paid whether or not you want it to at Y time of the month,” especially if it’s our first encounter with paying off debt and we don’t really know the self-discipline needed.

(On a side note, one of the reasons the program worked is because I was completely opposed to having an overdrawn bank account, so I *had* to make sure the repayment amount was covered. People who don’t/can’t set that priority probably wouldn’t do as well.)

Cheryle 2010/04/19 at 6:52 am

Katie, that is a lot like the program I am on now.
That auto deduct and payment plan is a big help and when I have a few extra $$ hanging around, I will make an additional payment.
I have paid off two cards earlier than expected this way and now the $$ that went to them is split between savings and another card.
Hopefully by year end, I will be debt free… I can’t wait to breath freely again..
oh and going forward, No cash, No buy !!
I have learned the difference between need and want.. that in itself is a big thing

paul 2010/04/19 at 8:54 am

Way to go Cheryle. Thanks for sharing your story here. When you hit debt freedom would you be sure to let me know? I’d love to interview you when the time comes, it’s always encouraging to hear!

WowMeow 2010/04/18 at 11:29 pm

I’ve worked at a collection agency for years:

1. The poster who stated you should get deals in writing was right on the mark! Many agencies will ‘accept a settlement’ but then not report it to the original creditor: Next thing you know, you are being called by a new agency for the remaining balance that you thought was written off.

2. Be aware that when you (or the debt settlement company) settles your debt, many creditors report it to the IRS: Don’t be surprised if you get a 1099 in the mail (you will have to pay tax on the un-paid portion of the debt)

3. The poster who stated that settlement companies don’t protect you from being sued: CORRECT! The creditor I handle – a worldwide creditor who’s name everyone on the planet knows- will send your account to an attorney for suit in less than 45 days if you do not handle your debt directly with the agency. Many of the people we talk to seem to think the debt settlement company is going to “protect” them from creditors and collectors; that is absolutley not true. Contrary to what most people think, collectors and collection agencies are not all filled with viscious maniacs: Most of us haev been where you are and really will try to work something out.

4. First, if you do decide that a debt settlement company is the right choice for you and your family, PLEASE go to the online Better Business site, and check out the settlement company you are considering before you sign up (do a Nationwide search – many of these companies have a home office elsewhere): You will find that this is a rogue industry with no regulation whatsoever (100’s of these ‘debt helpers’ sprung up overnight in response to the recent shifts in the economy and job losses). Almost all have a grade of ‘F’ by the BBB. Still unsure? Check with the FTC (Federal Trade Commission) and the Attorney General. The Mayor of New York is trying to shut down this whole ‘industry’! Please be careful doing business with these predators.

5. Yes, you CAN offer a settlement to your creditors or a collection agent: We agree to settlements 100’s of times a day. Be prepared to provide an explanation as to why you need a settlement (job loss, whatever). You will need to be able to pay the settlement in a lump sum payment or, if it is a bigger amount, over several months. GET THE SETTLEMENT AGREEMENT IN WRITING BEFORE YOU PAY ANYTHING! Be sure to request a ‘Settled in Full’ letter once your check has cleared (you can getit faster by paying via certified funds). If you are dealing with an idiot collector – some screaming moron who is demeaning, threatening, etc., ask for his Manager immediatley: you do NOT have to take that! Consumers have protection against bad collector’s/agencies: Look up the FDCPA (Fair Debt Collections Practices Act) if you believe your rights, or even human dignity, are being trampled upon.

6. I would usually disagree that a Chapter 13 or Chapter 7 bankruptcy is better than settling or repaying through a 3rd party: Keep in mind that a bankruptcy stays on your credit report for 7 to 10 years from the date of discharge/dismissal: but once you have ‘paid’ creditors off or settled your account, the damage to your credit willstart to fade within 2-3 years (most credit grantors only consider ‘recent’ credit history when making a decision to grant credit/funds). Sometimes filing bankruptcy is the right choice: I would look into both options before deciding. Almost everyone I talk to feels terrible if they file, like it was a personal failing: they are ashamed and embarrassed, but try not to feel that way: A bankruptcy is hard, but living the rest of your life, depriving your self and family in order to pay bills that will NEVER go away – well, that’s not right either. Wouldn’t you forgive a friend? Yes? Then forgive yourself too and don’t let having to file BK eat you up.

Hope hearing from the other side has helped clear some things up.

paul 2010/04/19 at 8:51 am

@WowMeow thanks so much for sharing your insiders view, I think that will be very enlightening for many people.

Cheryleann 2010/08/06 at 9:08 am


Thank you so much for this article. Some I knew and experienced and some of this was new to me… a lesson learned

Cheryle 2010/04/19 at 6:41 am

I have to admit, I am currently using a Credit Counseling service and it was a lifesaver for me.
Chapter 11 or Chapter 13 were not options I would consider. I got myself into this mess and swore I would pay off every cent owned, which really helped when negotiating with my creditors.
According to my creditors, I was lucky and picked a reputable service. A non-profit organization. Actually getting a contact name and number that I could use and pass on to the creditor was amazing to them. I did my homework and investigated quite a few.
One thing I leaned, it is a bunch of hooey that they will cut your debts in half. That is not realistic.
What they did do was get my interest down to 6% in some cases, but nothing higher than 14%. Compared to what the companies were charging, this was a major difference.
They worked with my creditors and got me to a place where I can handle the bills and in addition make extra payments and actually save money each month.
The cost.. $49.00 a month after the initial payment which is dependent on what you currently owe.
In addition, this allows you to call and ask questions, they give you information and guidance in a monthly newsletter support when needed.
If permitted, I will post this company here, but not sure how the rules go for something like this.

I wish anyone in this position peace of mind.. I know I was at my wits end

Joe 2010/04/26 at 11:25 am

I’d also like to point out that much of what these companies claim to do on your behalf is what you can do yourself – for free! And as Len said, if you’re too far gone or just incapable of managing your money Chapter 13 is likely a better course.

But the bottom line is that unless the person changes his habits and behavior, he’ll end up in the same place further down the road.

kevin 2010/04/27 at 6:15 am

Joe, changing behavior is the most important step. The absense of that is the reason so many of these plans don’t work. They can’t be used as stay of execution on your debts, but that’s how many people use them.

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