"Half Your Payments!" screams the headline. "Make one low monthly payment for all of your bills!"
When you see ads like this, they are usually from companies that help people with their credit. In this article, I'll talk about the main problem people face when they join one of these programmes and explain the basic ideas behind Credit Counseling.
First, let's get our definitions straight. The name "Credit Counseling" is actually quite misleading, since it has nothing to do with keeping or improving your credit score. In fact, Credit Counseling will often damage your credit, an unpleasant reality that is sometimes downplayed by industry representatives.
Credit counselling is a way to manage your debts by making a single payment to an agency every month. Then, that agency sends the money to your creditors on your behalf, ideally at lower interest rates so you can pay off your debts faster. Credit counselling is different from debt consolidation, debt settlement, and getting out of debt. Each of these debt programmes is very different from Credit Counseling in how it helps people.
Credit Counseling is by far the most popular way to deal with debt, with millions of Americans taking part. Does this mean it's the best option for most people who are having trouble paying their bills? No! There are many things wrong with this plan.
In the past few years, consumer groups like the Consumer Federation of America have been very critical of the Credit Counseling industry. But most of the time, these criticisms miss the mark. They usually focus on the pushy companies that use the fact that they are not-for-profit to trick people into thinking they are charities or that their services are free. In reality, these groups ask for big "voluntary" donations that can add up to hundreds of dollars and also charge high monthly fees.
But I'm not talking about bad companies that don't do much or any real "counselling" or ones whose only goal is to make their owners rich. No, I'm talking about problems with the way the business works. So, let's look at how Credit Counseling works in more detail.
Let's say you have debts of $25,000 on several credit cards. Let's also say that your average interest rate before you enrolled was 20%, which is actually low these days, especially if you've missed any payments. Your minimum monthly payments are $500, and you've been having a hard time making them. If you don't miss any payments, it will take you a whopping 109 months (more than 9 years) to pay off your debts at this rate.
You sign up for a Credit Counseling programme that says it will help you pay off your debts faster. But does it? Assuming that your creditors agree to be part of the programme, which isn't always the case, the real key is what they will do about your interest rates. In the past, creditors were more open to people who went to Credit Counseling, and they gave big discounts off of the normal interest rates. But they have been putting pressure on the industry lately, so the concessions aren't as good as they used to be. At the moment, most of the big players will lower interest rates to between 7% and 18%. We'll take the average, which is 12 percent.
So, how long will it take if you keep making payments of $500 per month at the new rate of 12%? First, we have to take out the fee that the agency charges every month. In this case, we'll use a $25-per-month fee, so $475 of your $500 will go toward paying down your debt. The good news is that you'll pay off your debts more quickly. The bad news is that getting out of debt will still take 75 months, or more than 6 years.
But what if you can't keep up with that $500 a month? Still, you went to a credit counsellor because you were having trouble paying your bills, right? Say you can only afford $450 per month. After taking out the $25 fee each month, you have $425 left to put toward your debt plan. Now you're looking at 90 months (7 years and 6 months), which isn't much better than the 109 months you started with.
So how can credit counsellors say they can cut your payments in half? Good question. If you only made $250 a month, you'd never be able to pay off your debt. At an interest rate of 12%, your debt will grow faster than your $250 a month can pay it down. The least you could pay each month is $300. But now it would take 20 years to pay off the debt, which isn't much better.
For the agency to really cut your payments in half, from $500 to $250 in this case, it would have to get rid of all interest. And even then, it would still take more than 9 years to pay off the rest! So ads that say you can cut your payments in half are just not true.
Keep in mind that in our example, we're assuming you're working with a good company that charges low fees and gets all of your creditors to lower your interest rates. Even if you work with the best credit counsellors, it will still take you between 5 and 9 years to pay off your debts.
Because of this, credit counselling usually only helps people who have short-term money problems. People whose finances have been unstable for a long time have a hard time making the regular payments that these programmes need to work. What happened? Even the best statistics show that about three out of four people don't finish Credit Counseling programmes.
If you decide to join one of these programmes to feel better temporarily, make sure you do your research first. Here are some tips to help you make your choice:
- Get a copy of the contract and carefully read it before you sign it. Make sure you know what all the costs will be. Are there fees to join? Contributions that are "voluntary"? Fees every month? Extra fees per account? All of these hidden costs can add up to a lot of money.
- Make sure that they offer help after the sale. Call their customer service number to see how quickly you can get through.
- Look for a company that gives budget advice and counselling the old-fashioned way. If they want to sign you up right away without asking how much money you have, leave.
- Look for a company near you that you can visit in person. Check out the company you're interested in with the Better Business Bureau in your area.
- Make sure that they will work with all of your creditors, not just some of them.
- Don't be fooled by the word "non-profit." That doesn't mean you're dealing with a good business, though. It doesn't mean the service is free, either.
Remember that you can get rid of your debts if you are responsible with your money, make a budget and stick to it, and don't use your credit cards unless you can pay off new balances in full every month.
Best of luck with your finances!
