Debt Management Programmes
Debt Management Programmes
Credit counseling (known in the United Kingdom as debt counselling) is a process offering education to consumers about how to avoid incurring debts that cannot be repaid. This process is actually more debt counseling than a function of credit education.
Credit counseling often involves negotiating with creditors to establish a debt management plan (DMP) for a consumer. A DMP may help the debtor repay his or her debt by working out a repayment plan with the creditor. DMPs, set up by credit counselors, usually offer reduced payments, fees and interest rates to the client. Credit counselors refer to the terms dictated by the creditors to determine payments or interest reductions offered to consumers in a debt management plan.
Common features of Debt Management Programs
After joining a DMP, the creditors will close the customer's accounts and restrict the accounts to future charges. The most common benefit of a DMP as advertised by most agencies is the consolidation of multiple monthly payments into one monthly payment, which is usually less than the sum of the individual payments previously paid by the customer. This is because credit cards banks will usually accept a lower monthly payment from a customer in a DMP than if the customer were paying the account on their own. Some DMPs advertise that payments can be cut by 50%, although a reduction of 10-20% is more common.
The second feature of a DMP is a reduction in interest rates charged by creditors. A customer with a defaulted credit card account will often be paying an interest rate approaching 30%. Upon joining a DMP, credit card banks sometimes lower the annual percentage rates charged to 5-10%, and a few eliminate interest altogether. This reduction in interest allows the counseling agencies to advertise that their customers will be debt free in periods of 3-6 years, rather than the 20+ years that it would take to pay off a large amount of debt at high interest rates.
A third benefit offered by credit counseling agencies is the process of bringing delinquent accounts current. This is often called "reaging" or "curing" an account. This usually occurs after making a series of on-time payments through the debt management program as a show of good faith and commitment to completion of the program. For example, a client with an account with a monthly payment of $50 which has not been paid in two months might be considered by the creditor to be 60 days past due. After joining the DMP and making three consecutive monthly payments, the creditor could reage the account to reflect a current status. Thereafter the monthly payment due on the statements would be the monthly payment negotiated by the DMP, and the account report as current to the credit bureaus. This process does not eliminate the prior delinquencies from the credit bureau reports. It merely gives a fresh start and an opportunity for the client to begin building a positive credit history. Like all derogatory credit information, the passage of time will lessen the impact of the negative marks when credit scores are calculated.
History of credit counseling
The first credit counseling agencies were created in 1951 in the United States when credit grantors created The National Foundation for Credit Counseling, or NFCC. According to W. Patrick Boisclair, Chairman of the NFCC's Board of Trustees, "the NFCC initially monitored legislative and regulatory activity for its retail credit members" and "also conducted public awareness campaigns on credit."(source) Their stated objective was to promote financial literacy and help consumers avoid bankruptcy, but they did not serve as collection agencies for the creditors. The first local credit counseling franchises emerged in the 1960s, offering education and counseling directly to consumers.
In 1993, the “Association of Independent Consumer Credit Counseling Agencies,” or AICCCA, was founded, citing a need for “industry-wide standards of excellence and ethical conduct.” This formally organized the NFCC’s competition. The AICCCA was formed from the group of counselors who favored telephone delivery of debt management programs. The NFCC was, in the beginning, strongly opposed to this telephone business model, primarily favoring face-to-face counseling as a more effective solution. Eventually, all organizations practiced both phone and face-to-face processes with some agencies using large inbound call centers driven by mass media advertising.
The credit counseling industry’s third major trade organization is its largest: the American Association of Debt Management Organizations, or AADMO.
However, not all credit counseling agencies belong to a trade organization, nor are they required to do so; there are well over 1,000 active credit counseling organizations in the United States.
In 2005, the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 made credit counseling a requirement for consumer debtors filing for Bankruptcy in the United States. In order to meet this requirement, during the 180-day period preceding the filing of bankruptcy, the debtor must complete a program with an approved nonprofit budget and credit counseling agency. Such a program may include, but is not limited to, one counseling session conducted by phone or over the internet. In addition, a post-filing debtor education credit counseling session is required in order to complete the bankruptcy process and to have your debts discharged.
Credit Counselling is also a growing industry in Europe, both for profit-making debt management companies and charities such as Christians Against Poverty and the Consumer Credit Counselling Service, Britain's largest debt advice charity.
Criticism of credit counseling (USA)
In the late 1980s and early 1990s, the number of credit and debt counseling agencies in America increased significantly. An antitrust lawsuit was filed against the NFCC, arguing that the presence of creditors on the NFCC’s Board of Directors constituted monopolistic practices. As a result of this litigation, creditors agreed to fund non-NFCC member agencies as well.
These sharp increases of credit counseling activity also created other, more serious issues in the industry. By the early 1990s, abuses by certain credit counseling organizations were so significant, it led to criticism of the entire industry.
A credit counseling agency typically receives most of its compensation from the creditors to whom the debt payments are distributed. This funding relationship has led many to believe that credit counseling agencies are merely a collections wing of the creditors. This fee income, known as “Fair Share,” are contributions from the creditors that originally earned the agency 15% of the amount recovered. However, in recent years, Fair Share contributions have dwindled steadily, with contributions of 4-10% being the most common.
Still the NFCC considers bankcard companies to be one of their primary "constituents," and the NFCC website promotes the fact that they collect $5 billion for creditors each year. It also promotes their efforts to steer consumers away from bankruptcy.
The Federal Trade Commission has filed lawsuits against several credit counseling agencies, and continues to urge caution in choosing a credit counseling agency. The FTC has received more than 8,000 complaints from consumers about credit counselors, many concerning high or hidden fees and the inability to opt out of so-called “voluntary” contributions. The Better Business Bureau also reports high complaint levels about credit counseling.
The IRS also has weighed in on the subject of credit counseling, and has denied nonprofit 501(c)(3) tax-exempt status to around 30 of the nation's 1000 credit counseling agencies. Those 30 credit counseling agencies account for more than half of the industry's revenue. Audits of non-profit credit counseling agencies by the IRS are ongoing.
Other organizations have voiced criticisms of the credit counseling industry, often citing the Fair Share funding model as evidence that credit counselors serve the interests of the creditors over the interests of consumers, and that credit counselors are not forthcoming in speaking out about the actions of creditors for fear of losing what little funding remains. Credit counselors respond that their job is not to take sides but to negotiate with all parties equally to help successfully resolve debts. They further argue that the steady decline in Fair Share funding belies the notion that creditors are in control of the credit counseling industry.
Another common criticism of credit counseling is the assertion that participating in a Debt Management Plan will ruin a consumer’s credit. Fair Isaac Corporation, the company that pioneered the use of credit scores, states that participation in a Debt Management Plan has no effect on a consumer's FICO credit score. However, the participation in such a plan may appear on consumer credit reports, and the client may have more difficulty obtaining a car or home loan and be denied any further unsecured credit, such as a credit card. This is because lenders often use multiple risk factors to determine creditworthiness. The major factor holding consumers back is the amount of debt they have relative to their income (the debt to income ratio) and not enrollment in a credit counseling plan. While credit card banks offering relatively low-credit-line cards may use a credit score alone to approve a new account, a mortgage or car lender typically will scrutinize the entire credit report more extensively and verify employment and income information. Some lenders view a prospective customer's participation in a Debt Man
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