How Does Debt Counseling Work?

Frustrated couple checking bills at home using laptop

Credit is one of the most powerful tools in your financial toolkit, but it's important to manage it effectively. Maybe you've accumulated debt because you've had a string of unexpected expenses or you lost your job. Or maybe you're still carrying a load of debt from student loans or a past medical crisis. If your debts are large and growing, and you're unable to pay them down, you may want to consider debt counseling.

Debt counseling gives you the financial education, tools and insights you need to get a handle on your finances. Debt counseling can bring relief, but it's not a quick fix. Your debts won't instantly disappear, nor will any credit issues you may have developed along the way. Instead, the process can help you find new ways to approach your challenges so that the hard work you do to manage and pay down debt is more likely to be successful.

What Is Debt Counseling?

Debt counseling, also called credit counseling, involves working with a professional who helps you assess your financial situation and work out practical solutions for improving your financial health, including paying down or paying off debt. Among the items a debt counselor can help you with:

  • Objective feedback on your finances—income, expenses and debt.
  • Actionable suggestions for making things better, for example by finding ways to bring in more income or reorganize your expenses.
  • A better understanding of your debt, including your rights and responsibilities as a borrower.
  • Devising a strategy to tackle your debts and improve your financial health.
  • Establishing a debt management plan that keeps you on track month by month.

Here's how debt counseling works: If you decide to work with a debt counseling agency, you'll sign an agreement and provide information on your finances. A credit counselor will contact you—often by phone—to talk about your concerns and objectives and discuss ideas for addressing your finances. As part of this service, your counselor may create an action plan for you.

You may also decide to work with your counselor to establish a debt management plan. This is an ongoing agreement that typically includes a small upfront fee and an ongoing monthly fee. With this arrangement, you make one monthly payment to the debt counseling service; they, in turn, make monthly payments to your creditors. By communicating with your creditors and taking your whole financial picture into account, debt counselors may be able to help you devise a plan to pay off your debts in three to five years.

Debt counseling is not the same thing as debt settlement. Debt settlement companies attempt to negotiate reduced payments with your lenders, generally in exchange for a fee. In a debt settlement arrangement, you may indeed pay less than the full amount of your debt. The hitch is that you'll typically be asked to stop making payments on your debt, which will cause late payments to appear on your credit report and seriously damage your credit. If the settlement process is successful, the account will appear as "settled for less than originally agreed" on your credit report, which can also result in credit score harm. Late payments and settled accounts stay on your report and affect your credit score for up to seven years. It's best to avoid debt settlement in all cases unless bankruptcy is your only other option.

How Can Debt and Credit Counseling Impact Your Credit?

A debt management plan you create through credit counseling may help you avoid credit score harm. Your counselor may be able to help you negotiate a lower interest rate or lower minimum monthly payments that make it easier for you to repay your debts—but without settling your debt for less than its original value. In this way, you may be able to save your credit score and report from a negative hit.

Ideally, debt counseling should improve your ability to repay your debts on time and manage your credit successfully. Timely payments every month help raise your credit score over time. Assistance with budgeting may enable you to use credit more effectively and stay away from unmanageable debt in the future. As for the counseling itself, it has no direct effect on your credit score.

Is Debt Counseling a Good Idea?

If you're feeling overwhelmed, debt counseling may indeed be a good option for you. Being stuck in a cycle of debt isn't just tiring; it can also be confusing, isolating and even paralyzing. Working with a professional credit counselor can help you overcome these obstacles.

That said, debt counseling doesn't work equally well for everyone. Credit counseling can be a catalyst for change, but only if you're prepared to do the work of creating and maintaining a plan. While initial consultations with a credit counselor are free, you'll pay a small ongoing fee above and beyond your monthly debt payments if you opt for a debt management plan. Before starting debt counseling, be ready to learn and make changes. A good credit counseling service can give you tools, but only you can use those tools to create a better financial position.

How to Find a Debt Counselor

There are for-profit and nonprofit debt counseling services. Working with a reputable nonprofit service is the best way to go. In particular, be wary of for-profit "credit repair" companies that promise to fix your credit or erase negative information in exchange for payment. These companies are often scams, and won't do anything for you that you can't do yourself for free. Under the Credit Repair Organizations Act, companies offering credit repair services may not demand advance payment and must provide written contracts for their services. As a consumer, you have the right to cancel. If you have a problem with any credit repair company, file a report with your local consumer affairs office or your state's attorney general.

For help finding a nonprofit debt or credit counseling agency, check out the National Foundation for Credit Counseling and the Financial Counseling Association of America. Either can help point you in the direction of a certified credit counselor. The U.S. Department of Justice also maintains a list of approved credit counseling agencies by state.

Keeping Wise Counsel

Credit is a powerful financial tool, one that's worth keeping sharp over time. Working with a debt counseling agency can help you better understand your finances—and the choices you have for improving your financial health. As you work on paying off your debts and improving your credit, you can access your Experian credit report and score to track your progress, or consider free credit monitoring to help you stay on top of changes as they occur.

How Good Is Your Credit Score?

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