What is credit counseling, and how can it help you?

Perhaps you’re at the end of your rope. You’ve tried transferring your debt to a balance transfer card or applying the avalanche method, but one thing led to another, and you’re still drowning in debt. Or perhaps you’d like to improve your understanding of credit, so that you don’t fall back into debt, but don’t know where to start.

Consider signing up for a credit counseling session — which are typically offered by nonprofit credit counseling agencies to help you improve your financial literacy or set up a payment plan to manage your debt once and for all. Read on to learn more about how credit counseling works and if it’s the right move for you.

What does a credit counselor do?

First and foremost, a credit counselor will give you a comprehensive analysis of your entire financial situation to help you come up with the best solutions for you. Depending on your situation, a counselor may educate you further on managing your finances, help you create a personalized budget or forge a debt management plan (DMP) with you. Secondly, a counselor recognizes that whatever plan is ultimately recommended it has to work for both you and your creditors.

No, this doesn’t mean that they work for the creditors. They work for you. But the reality is that creditors have certain rights and remedies, and you took on certain repayment obligations when you turned the credit they gave you into debts that need to be repaid. Coming up with a workable solution that benefits both parties while trying to preserve your credit is the Solomon-like task these nonprofits take on.

A good counselor is going to want to know how much money you take home, how much money you spend and how much money you owe. While this may sound pretty simple, not everyone immediately knows these facts.

While your rent and your car payment will probably be easy to spell out, how easy will it be for you to recall how much your car registration tags cost you every year? Do you know (or at least have a pretty good idea) how much you spend annually on birthdays and holidays? How about car maintenance? Going out to eat? Anything you spend money on is going to be important to help your counselor get a good idea of how much discretionary income you have to work with.

When do you need a credit counselor?

Put simply, a nonprofit credit counseling agency serves as an objective resource to help you see your situation dispassionately. It can offer individualized solutions for resolving your credit and debt issues.

Contrary to popular belief, your situation does not have to be dire for you to call a credit counselor. In fact, credit counseling is also great for anyone new to credit and would like to learn more about budgeting and developing your financial literacy.

Don’t be ashamed of your inexperience in personal finance. If you come from a family of credit invisibles (which, according to the Consumer Financial Protection Bureau, consists of around 11 percent of Americans), and you’re the first person in your family to use a credit product, it’s likely that you’ll encounter some mishaps while embarking on this journey. Alternatively, you could be a responsible cardholder usually, but one bad turn with the flu or an injury that caused you to miss work for a whole week, without pay, may bury you in a pile of debt.

In that case, calling a credit counselor could help you manage your debt, before it gets uncontrollable, or break you out of that paycheck-to-paycheck lifestyle. Ideally, you’d make the call before becoming seriously delinquent on any of your accounts, since you’ll have more options available before defaulting. This is especially true of mortgages.

Your first call will cost you only your time. You will very likely walk away with a better understanding of your financial situation and some valuable credit education.

It’s also never too late to give credit counseling a try before you move on to other, more drastic solutions, like bankruptcy. The credit counselor may still be able to devise a plan for you to pay off your debts without you filing for bankruptcy.

If your specific case calls for a nuanced approach, credit counseling is a great option to pursue to gain more clarity on your next steps. It is particularly useful in difficult-to-understand situations such as:

• Mortgage defaults: The rules are complex, the dates inflexible and the servicers often ineffective. A HUD-certified credit counseling agency (not all are) can lead you through the intricate process and may help get you special access to decision makers.
• Multiple collection accounts: Conflicting demands from multiple collectors can make it impossible to come to terms with all of them.
• Joint credit issues: While they are not marriage counselors, an outside dispassionate point of view can help you find clarity and a solution.
• Bankruptcy: Credit counseling is required by law as part of the bankruptcy process. A counselor can help you understand what really happened and avoid those issues in the future.

What to expect from a credit counselor

Your first call to a credit counselor could last up to an hour and a half because the best counselors will want to make sure that you and your creditors are a good fit, and that will take knowing details — lots of details. When it comes to your debts (such as credit card debt), your counselor may want to get your permission to pull your credit report. This is not a requirement, but it’s useful.

The counselor will perform a soft inquiry, which won’t impact your credit score. However, it may save a little time in detailing your accounts with your counselor. For the rest, a great way to prepare for a call to a credit counselor is to review your expenses for a month. Check your credit card statements, checking account statements and ATM withdrawals to know exactly how much of your paycheck goes where.

At the end of your initial consultation, your counselor will lay out your options. These may include referrals to additional resources, a DMP, a debt repayment plan with some debt forgiven (also known as a less-than-full-balance DMP) or bankruptcy. However, these referrals could also just involve suggestions for bringing in extra income or trimming your budget to bring it in line with your current income.

What is a debt management plan?

Though credit counseling agencies offer many services, many turn to them when their debts have become too much to handle. Credit counselors often offer debt management plans to consolidate a consumer’s various debts, whether you owe credit card debt or medical debt or personal loans or more.

Working together with your counselor and accounting for your current income and ongoing expenses, you’ll draft up a payment plan (which usually lasts three to five years) to totally pay off your debt. Another incentive is that issuers may reduce your interest rates if you agree to a DMP.

Rather than pay each creditor in separate payments, you’ll make one payment to the credit counseling agency, which will distribute it to your various creditors. Keep in mind: For their trouble, the agencies may charge you a fee.

Does hiring a credit counselor hurt your credit?

Speaking to a credit counselor will not have any impact on your credit score. In fact, unless you choose to enroll in a DMP, there is no way for anyone to know you are working with a credit counselor, unless you choose to divulge that information.

The only thing that might bring your score down is if the debts or credit cards you put on a DMP are still open. Most plans require that your cards be closed, and that will affect your available credit and your credit utilization, an important factor in your credit score.

Closing your cards will also shorten your length of credit history — lowering your credit score. This may seem counterproductive, but for those of you struggling with debt, it’ll help you more than hurt you by preventing all accounts from accruing excessive interest so that you can focus your efforts and payments on paying off the amounts you currently owe.

Plus, the benefits of a DMP could be worth the initial hit you take, especially if you already have a history of late payments. Remember that your payment history makes up 35 percent of your FICO score, which is why late payments affect your score so much.

Agreeing to make regular monthly payments, after committing to a DMP, will improve your score after its initial hit since these payments still count toward building a positive payment history. Plus, many creditors will re-age your accounts sometime during your DMP — bringing your past-due accounts current so that your payments are considered on time and count toward your credit score (rather than playing catch up on past-due accounts).

All in all, participating in a DMP to clear your debt will significantly improve your credit score in the long term. In fact, your credit score should improve year over year after starting your DMP, according to Money Management International.

How much does it cost to use credit counseling?

Your first call is usually free. If you choose to enroll in a DMP, you will be charged a small monthly fee and you may have to pay a one-time set-up charge. As for bankruptcy certificates, they’re usually about $50.

These fees are regulated by your state, but monthly fees are typically $20 to $75 and set-up fees are usually $30 to $50 (though $79 is the national cap for DMP fees). However, one of the best things about a DMP — besides stopping collection calls — is the reduction in interest rates and the elimination of late and over-the-limit fees, which should cancel out any fees you pay for the service.

How do you find a good credit counselor?

Do not mistake nonprofit credit counseling organizations for for-profit debt settlement companies. A debt settlement — you settling your debts with creditors for less than you owe — is entirely different from credit counseling and should be approached with caution, as debt settlement can cost your wallet and credit score dearly.

When seeking a good credit counselor, you should look for those connected with nonprofits and are independently accredited with certified financial counselors. These are mission-driven professionals that will only act in your best interests (and not their own).

A good place to start is the National Foundation for Credit Counseling, the oldest credit counseling organization in the country, with almost 100 non-profit member agencies across the nation. The Financial Counseling Association of America is another nonprofit that connects consumers seeking counseling on credit, housing, student loans and more. Like other services, it’d be useful to check online reviews of the agencies you’re connected with so that their services and benefits align with your needs, if possible.

The United States Department of Justice also keeps a list of approved credit counseling agencies that you can narrow down by state and judicial district. The list also details agencies’ supported languages in case you’d prefer counseling in a language other than English.

Bottom line

Should you seek credit counseling? For many — whether you’re trying to learn how to budget properly or wrangle your debts before they worsen — it could be an essential step for finally taking charge of your finances. Though you’ll have to pay some fees for the service in exchange for greater financial literacy and management for the rest of your life, it could be worth it.