Credit counseling is a process where financial professionals help individuals manage their financial situation, including debt commitments, budget, and financial plans.
What Is Credit Counseling?
Those who seek credit counseling typically do so when the burden of their financial commitments becomes too heavy, and they start having difficulties in managing their credit. A credit counselor provides a carefully outlined plan that the individual can follow to progressively improve their situation.
What’s the Purpose of Credit Counseling?
Credit counseling has various goals depending on each individual’s credit and financial situation, but the most common ones are:
- Educate the debtor: Most credit counseling programs include a series of workshops and courses designed to educate individuals in wisely managing their money. These courses are meant to prevent future situations where a person’s finances consist of excessive debt or unwise money management decisions.
- Provide assistance in managing money and debt: Credit counselors provide individuals with tools and knowledge that they can use to improve the way they handle their finances, including their income and debts.
- Develop a plan to progressively improve the individual’s financial situation: More than 60% of Americans seek credit counseling due to reduced income, which makes it difficult to stay current with their debts. The purpose of credit counseling is to come up with a plan that helps the individual in managing the situation.
- Create a budget: Roughly two-thirds of U.S citizens do not follow a budget, which reduces their ability to manage their finances effectively. For this reason, one of the first steps of credit counseling involves drafting a budget that portrays the financial reality of each person.
How Does Credit Counseling Work?
Each credit counseling program has its own procedures and steps, but most of them share some of the following aspects:
- First meetings/discovery sessions: In most cases, credit counseling is done through phone interviews, over the internet, or a personal meeting. During this initial session, the counselor usually tries to understand the person’s current financial and credit situation to evaluate his or her needs and provide appropriate counseling and assistance.
- Drafting a budget: Most credit counseling sessions require that the individual provides information about his or her income, expenses, and debt. The counselor then drafts a budget that helps to outline the right strategies to deal with the situation.
- Debt management plan: After the information from the participant has been evaluated, most programs draft a “debt management plan.” This document indicates the next steps that the individual will take to reduce the burden of the debt.
- Training and resources: Credit counseling programs usually suggest (or require) that the individual attends certain workshops or training sessions to educate them about money and debt matters.
- Money management tips: Most counselors also provide practical tips to help individuals manage their money and debt wisely.
When Should an Individual Seek Credit Counseling?
According to a study from the National Foundation for Credit Counseling (NFCC), these are the most common reasons individuals seek credit counseling:
- Reduced income: A person’s financial situation may be hurt by job loss or underpaid jobs that are not a good fit for their budget.
- Increased expenses: Medical bills are one of the most common issues that affect an individual’s financial situation. These debts can exceed their payment capacity if they are not properly managed.
- Bad credit: People with low scores and challenging credit situations often face difficulties accessing credit, or the terms and conditions for borrowing may be expensive. This affects their budget and their capacity to effectively manage their financial situation.
Each of these instances can prompt individuals to seek professional counseling, and various associations and institutions have emerged in the United States to assist them.
Who Can Provide Credit Counseling?
A credit counselor is usually a financial professional who has been certified by a reputable institution in the United States to provide their services to the public. The three most widely known credit counseling institutions in the United States are:
- The Financial Counseling Association of America (FCAA)
- The National Association of Certified Credit Counselors (NACCC)
- The National Foundation for Credit Counseling (NFCC)
These institutions have earned their reputation by providing assistance through a network of certified counselors who can help individuals in managing their financial situation more effectively. Additionally, some expert recommendations that might help individuals in choosing a credit counselor include:
- Accreditations and qualifications: To be considered reliable, credit counselors should have the proper academic background, experience, qualifications, and accreditation.
- Services offered: To assist in each person’s unique financial situation, a credit counselor must be able to provide the right services, which typically include debt counseling, bankruptcy counseling, housing counseling, student loan counseling, financial planning, and budgeting.
- Education and materials: Most credit counseling programs provide educational materials, workshops, and courses to help individuals in improving their situation. These materials and courses can be provided for free, or there might be an enrollment fee involved.
- Fees involved: To understand the cost of credit counseling, ask the counselor to provide a proposal that discloses the total cost of the program.
- Compensation matters: There could be instances where a counselor could be compensated by third parties for enrolling new clients into specific products or services. This kind of relationship should be disclosed by the counselor to avoid conflicts of interest.
Credit Counseling and Credit Scores
Seeking credit counseling does not directly affect a person’s credit score. However, implementing the debt management measures and strategies provided by the counselor may ultimately result in an improvement in the person’s credit situation.
Credit counseling should not be confused with credit repair as these activities have both different goals, purposes, and are conducted differently. Their main differences include:
- Purpose: Credit counseling assists individuals in improving their financial situation by providing a carefully outlined plan the person can follow to reduce debt and manage their money more efficiently. Credit repair, on the other hand, seeks to improve a person’s credit score through various strategies, including the removal of negative items or inquiries and the addition of tradelines to their credit reports to artificially boost their scores.
- Cost: The cost of credit counseling mainly consists of fees paid to the counselor, along with the cost of any materials involved. The cost of credit repair varies between providers, yet in most cases, it is significantly more expensive than the fees charged by counselors.
- Effectiveness: Credit counseling is provided by accredited professionals who have the knowledge, background, and experience to provide assistance that potentially yields positive results. Credit repair is carried on by private companies, and its effectiveness is doubtful as most credit items will only be removed by credit reporting agencies after a certain number of years have passed.
- Legitimacy: Credit repair companies have been the subject of legal conflicts for many years as they operate in a gray area of the law. Credit counselors, on the other hand, are usually certified professionals whose services are monitored by reputable institutions.
Credit Counseling Statistics
The following statistics show some relevant aspects regarding credit counseling in the United States based on the information provided by the NFCC in a 2016 research report:
- The average monthly income of individuals seeking credit counseling was approximately $3,400, and their monthly debt-related expenses were nearly $1,350.
- The average amount of savings per individual was almost $1,200.
- Around 75% of people who seek credit counseling are not saving money.
- Roughly 41% of the people surveyed reported that they paid the minimum amount due on their credit card each month.
- Around 50% reported that they have received more than one call from a collector.