How Consumer Credit Counseling Services Work

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If you’re struggling with or overwhelmed by your unsecured debt (typically credit card debt), then you should consider getting some debt relief before things get too out of hand. Aside from bankruptcy, which is the most drastic route used in only the most extreme debt situations, the two most commonly used methods by consumers with serious debt problems are consumer credit counseling (also known as debt management) and debt settlement. The principal dividing line between these two approaches can be best understood by recognizing that consumer credit counseling is the method supported by the credit card companies themselves, while debt settlement requires a strategically developed negotiation process in opposition to the credit card companies.

How Consumer Credit Counseling Services Work

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A credit counseling service establishes a planned method of debt relief for consumers. This involves educating them on how to properly manage and budget their money as well as arranging for them to pay off their debts through a debt management plan (DMP). This is why “credit counseling” and “debt management” are often used interchangeably.

In a DMP, the credit counseling organization acts like a middleman between you and your creditors. They collect monthly lump sum payments from you, which they then disperse to your creditors until all your debts are cleared. The credit counseling organization will also contact your creditors and explain to them that you are enrolled in a DMP. Creditors may agree to reduce interest rates and waive certain fees and late payment penalties if you are repaying through a DMP.

How a Credit Counseling Service Makes Money

The lower rates are not arrived at individually through negotiation (as in debt settlement), but instead are predetermined according to a set formula if the credit counseling company is already well-established. So if the debt management companies don’t have to negotiate on your debt, then on what basis do they make their money? There are two ways that they make their money:

From the consumer – they charge a monthly management fee and an initial set-up fee for the services they provide for the consumer.
From the credit card companies – they receive payments for getting the consumer to pay the full balances that they owe.

Overall, a credit counseling service is the debt relief method preferred by the credit card companies as it involves full repayment of the balances owed to them. In contrast, debt settlement programs significantly reduce the balances owed to the credit card companies, which for them is obviously a much less desirable outcome. Credit card companies try to collect the full balances owed through their association with consumer credit counseling services.

For more information on debt management plans, please visit the Federal Trade Commission.

This post has been featured in the Carnival of Debt Reduction.