Should Consumers Go With Credit Counseling or Debt Settlement?

The housing crisis, the recession, and the resulting job losses from both have many consumers seeking assistance for debt of all kinds. Add to these challenges the fact that credit card companies have been raising rates, fees, and payments in reaction to the passage of the Credit Card Accountability, Responsibility, and Disclosure Act and the distress for consumers is at highs not seen since the Depression. For consumer debt, borrowers now have several options including debt consolidation, credit counseling, bankruptcy, and debt settlement. As the circumstances surrounding debt consolidation and bankruptcy have resulted in fewer benefits for consumer, many are now making the choice between credit counseling and debt settlement.

Credit counseling is generally the best known of the pure debt relief options, having been around since the early 1990’s. The service was originally provided to consumers by non-profit organizations like The National Foundation for Credit Counseling and its affiliates, Consumer Credit Counseling Services. While mostly unknown to consumers, the organizations were designed and backed by the credit card companies to act as a mediator between consumers and credit card companies. The counseling organizations would then “negotiate” lower interest rates and monthly payment plans for consumers that had fallen behind on their payments to keep them on track with payments instead of walking away from their debts. These marginally lower payments are the primary benefit of credit counseling.

The services were widely advertised and offered in cities across the country. As a side note, if consumers defaulted on their credit card debt, the vast majority of accounts would end up going to arbitration as a condition of the terms of the credit card contract. The two biggest arbitration firms, as it was revealed recently, were also backed by the credit card companies with an astounding 97% of rulings going against credit card holders.

As consumer debt began to increase rapidly in the late 90’s, hundreds of opportunistic new companies set up shop in the area of credit counseling to provide similar services on a “for-profit” basis. Many of the new companies positioned themselves as credit counselors and alluded to being non-profit organizations while operating very much like any bottom line oriented corporation. To broaden their offerings with higher profit margin services, many of the firms began offering services that weren’t considered to be credit counseling at all including referral agreements with bankruptcy attorneys, mortgage brokers, and real estate agents which were often not disclosed to the borrowers which had signed up for “counseling”.

While the services that may be offered as part of credit counseling has evolved considerably over the last ten years due to the companies that now populate the category, the relief option offers fewer benefits to the consumer than the newer, more aggressive option of debt settlement which has reduced its popularity considerably. In fact, current statistics show that 75% of consumers that enroll in credit counseling drop out before completing the program.

The dropout rate is very similar to that of bankruptcy workouts and much less than the rate seen in debt settlement proceedings. The best description of the benefits derived from a debt settlement was recently released in a study on the process out of Southern Methodist University. In the words of the team which conducted the study, debt settlements “…create the greatest consumer welfare of any approach.”

The study, which covered 4,500 randomly selected consumers, found the following:

1) Completion rates of 40% over two years were much better than the estimated rate of 15% within one year. In fact, that rate is similar or better than other subscription based service industries, such as mobile telephone and cable television companies, which have Better Business Bureau certified members. The 40% of debt settlements being seen through to completion is 60% greater than the amount of consumers that complete payment schedules set up through a credit counseling arrangement.

2) Debt settlement offers as a rule came in under 50% of the original balance of debt versus no reduction in debt balances through credit counseling. The reduction in debt balances facilitates faster payoffs by indebted consumers.

3) Debt settlements can include credit cards, department store debt, unpaid medical bills, unpaid utility bills, and many other forms of unsecured consumer debt.

4) Debt settlement reduces payments immediately and by a far greater percentage than offered through credit counseling. Payments are typically reduced on all debts in the process by approximately 50%.

5) Balances are typically paid off within 18 to 48 months, much faster than credit counseling.

6) Debt settlement has an increasingly higher value to customers with higher account balances and higher total debt, potentially saving millions of dollars for consumers when compared against the full payoff of balances and the marginally reduced payments as seen in credit counseling.

7) Once “fair share” payments are taken into account for credit counseling fees on a consumer account can exceed 29% of the consumer debt, levels which the study calls “exorbitant.”

Neither form of debt relief is the perfect answer for everyone but indebted consumers are increasingly finding that debt settlement can provide optimal results for their personal circumstances. Credit counseling is likely the best fit for those consumers that need a very small amount of assistance while the benefits of debt settlements can help consumers with higher amounts of debt as well as those needing bigger reductions in their monthly payments. Additionally, debt settlements can play a major role in getting home loan modifications approved when a consumer’s overall debt might otherwise result in a non-approval. Be sure to consult a professional with experience in both debt relief solutions as well as loan modifications where applicable to determine which one is the best for you.

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