Liz Pulliam Weston: A consumer's guide to credit counseling

The Basics

Is credit counseling right for you?

Credit counseling, debt settlement and debt consolidation are not all the same -- and it's important to know what you're getting when you sign up.

By Liz Pulliam Weston
MSN Money

Ryan and his wife owe $50,000 on their credit cards. They're still making their payments on time, but they aren't making much progress in reducing the debt. Ryan doesn't want to file for bankruptcy or try to negotiate settlements, saying, "I believe in paying what I owe."

"Is there a way to just pay off these balances without accumulating interest?" Ryan asked me recently in an e-mail. "I realize I will have to close these accounts. But if I can just be allowed to pay on the balance without being charged large interest, we will actually be able to get out from under this mess in a few years!!"

Ryan may be a good candidate for a credit counselor's debt-management program, which is meant to help borrowers pay off their credit card debt over several years, often at reduced interest rates.

But credit counseling isn't a good fit for every overwhelmed borrower, and it has a serious image problem. Bad guys overwhelmed the industry in the 1990s, tainting its reputation. In addition, many people still have trouble understanding the differences among various credit-management options, including credit counseling, debt settlement and debt consolidation.

In fact, Ryan, in his e-mail, confused credit counseling, which is designed to pay back all of what a borrower owes, with debt settlement, which is designed to negotiate payoffs of 50% or less of what the borrower owes. (You can read more about debt settlement here and here.)

Here's when a credit counselor's debt-management plan may help you:

  • Most of your troublesome debt is on credit cards. Debt-management plans typically can't deal directly with overwhelming medical bills, student loans or other debts, although a credit counselor may offer advice about budgeting and money management that could help you cope with these bills.

  • You have, or can develop, the discipline to stick to a fairly strict budget. A debt-management plan requires you to turn over a certain dollar amount each month to the credit counselor, who distributes the money to your creditors, and you usually have to trim your spending fairly deeply to come up with the cash.

  • You're determined to avoid bankruptcy or debt settlement. Credit counseling is designed to help you avoid bankruptcy or debt settlement, but bankruptcy in particular can be a faster way to wipe out your debt and give you a fresh start. You can find out more here.

  • You're not already in too deep. The problem with this form of help, as I wrote in "Why credit counseling often fails," is that people wait too long to seek aid. If you have enough income to pay the minimums on your bills and a little bit extra, you'll have the best shot at success with credit counseling. Otherwise, bankruptcy or debt settlement may be better options.

The morphing world of credit counseling

For most of credit counseling's history, the industry was dominated by the National Foundation for Credit Counseling, whose nonprofit affiliates -- usually known as Consumer Credit Counseling Services -- offered lower interest rates and payment plans for people who had fallen behind.

A rise in consumer debt in the 1990s helped spawn hundreds of competitors, many with million-dollar advertising budgets, slick Internet come-ons and sound-alike names.

Some did a good job of negotiating repayment plans. Others charged fat upfront fees, paid their executives even fatter salaries and pocketed much of the money that could have gone to pay off creditors. Some targeted people who weren't even late on their payments, but who were simply disgruntled about their interest rates.

The worst were fly-by-night outfits that disappeared with clients' money, destroying their credit scores in the process.

The Federal Trade Commission eventually took action against several big players in the industry, including now-defunct Ameridebt, and the Internal Revenue Service stripped many others of their nonprofit status. Without nonprofit status, the counselors weren't able to collect "fair share" payments, fees from credit card lenders that represented a portion of the repaid debt and that made up a substantial portion of their budgets. Most went out of business.

Continued: What to watch out for

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