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Credit counseling 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 sometimes 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.

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. Their stated objective was to promote financial literacy and help consumers avoid bankruptcy.

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.

Criticism of credit counseling

In the late 80’s and early 90’s, 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 1990’s, 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.

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 1,000 credit counseling agencies. Those 30 credit counseling agencies account for more than half of the industry's revenue. Further audits of nonprofit credit counseling agencies by the IRS are ongoing.

The lobby against credit counselors arises from the belief by the collection industry that the not-for-profit status of the credit counselors gives them an unfair financial and market advantage over them. The IRS apparently agrees. The tax exempt revocations seem to be centered around whether a tax exempt credit counselor actually performed their mandated mission by assisting the community at large, other than their whole attention to their own DMP customers in a "collection practice" (no one knows for sure however).

Congress has also investigated the credit counseling industry, and issued a report that said while some agencies are ethical, others charge excessive fees and provide poor service to consumers. The report also stated that NFCC member guidelines, if applied to the entire credit counseling industry, would go a long way toward eliminating the abuses they uncovered in some parts of the industry.

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 the FICO credit score. However it should be noted that a client active in a Debt Management Plan may not be able to get a loan or successfully obtain credit.

Given this criticism, the industry is likely to be changed forever in the immediate future as it is scutinized by both the consumer and government regulators over how they will be paid for the services they perform. In meantime, there will be no shortage of debt-burdened consumers who will now be facing a burgeoning, and more traditional, collection industry.

External links

• IRS Revoking Exemptions Of Credit Counselors
• Bankruptcy Abuse Prevention and Consumer Protection Act of 2005, Section 106
• US Trustees list of approved credit counselers for Bankruptcy
• FTC Consumer Alert: New Bankruptcy Law Requires Credit Counseling Before Filing
• FTC explains New Bankruptcy Law Requires Credit Counseling Before Filing
• FTC New Bankruptcy Law Requires Credit Counseling
• FTC Testifies about Credit Counseling Abuses
• Fiscal Fitness: Choosing a Credit Counselor
• FTC, IRS, and State Regulators Urge Care When Seeking Help from Credit Counseling Organizations
• (pdf) The Impact of Credit Counseling on Subsequent Borrower Credit Usage and Payment Behavior

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