If you are struggling under a load of debt you could do as have many Americans and that’s go to a consumer credit counseling agency for help. The best of these agencies are nonprofits and offer many of their services free. While credit counseling can be an excellent option there are a number of myths that have sprung up about it and you need to know the truth.
Debt management programs and credit counseling – it’s all the same
Regardless of what some people might tell you there is a big difference between consumer credit counseling and debt management plans. For one thing, credit counseling usually involves helping a customer create a budget and stick to it. Many credit counseling agencies offer seminars in money management and have whole racks of free brochures with information about debt and money management. In short, consumer credit counseling is about education and it’s best for people who earn a decent wage but at the end of the week don’t have enough money to cover their expenses and don’t understand why.
In comparison, a debt management program (DMP) is where the agency acts sort of like a policeman that takes your money in the form of a monthly payment and then distributes it to your creditors until all your accounts are at zero. Most credit counseling agencies will also negotiate with your lenders to get your interest rates reduced and any late fees waived so that you will have a more affordable monthly payment. One big downside of a DMP is that all of the lenders that accept your plan will close your accounts meaning that you will need to learn to live without credit cards for anywhere from 4 to 5 years.
A good credit counselor can get your monthly payments cut in half
This is just not true. As noted above, a good credit counselor can get your interest rates reduced and any fees waived but there’s no way this will cut your monthly payment in half except in the very narrowest of circumstances. For example, if you were to miss $200 payments on a $10,000 balance then you would owe $600 the next month. A skilled credit counselor might be able to get that bill re-aged reducing your payment back to $200. But you haven’t really saved anything. The missing $400 was just tacked back onto the total amount you owe.
There are agencies that can negotiate lower DMP payments
Here’s another myth. Credit counseling agencies could negotiate lower payments only if there was some negotiation involved. However, there isn’t. If you’re talking to a counselor who promises that he or she can negotiate lower DMP payments, you’re actually talking with a debt settlement company. This is where you transfer a set amount of money each month into an escrow-type account. When enough money has accumulated in your account to settle one of your debts, the settlement firm will contact you and ask that you release enough money to cover it. This continues until all of your unsecured debts have been repaid.
If you want to get out of debt you need a formal program
Many lenders will enroll you in a special reduced-interest program if you approach them as an individual. The downside of this is all of the phone calls you’ll have to make and that you’ll have to show you’re having some kind of financial emergency. But you certainly don’t need a formal program for this. You could handle the entire thing yourself. The same holds true if your objective is to consolidate your debts through a debt consolidation loan. If you have available equity in your home, you could get either a homeowner equity line of credit or a home equity loan yourself – without the help of any third party.
A DMP will help your credit rating
If the reason why you’ve chosen consumer credit counseling is because you’re behind on your bills a DMP will do nothing to help your credit rating. These missed payments will is already be on your reports and there’s nothing that can be done about them. However, by itself a DMP is score-neutral — it won’t effect your credit for good or bad. However, when creditors see they are being paid through a DMP they will likely take this as a good sign, that you’re doing your best to repay your debts.
Here’s a short video that explains what makes up your credit score and why it is not effected by a DMP
Debt settlement is always cheaper then debt consolidation
There is no question that debt settlement will save you money. The reason for this is simple. A good debt settlement counselor should be able to get your debt settled for about 40% or 50% of what you owe. In comparison, consumer credit counseling basically means just moving your debts from one set of lenders to a new one — the credit counseling agency. In either event, you’ll end up owing exactly what you owed before. Unfortunately, there is a hidden cost to debt settlement, which is the effect it will have on your credit score. Debts that have been settled are never reported to the credit bureaus as “paid in full”. Instead, they are reported as “settlement”, “settled” or “settled for less than full amount”. Whichever the case, this will definitely ding your credit score. Of course, if you’re so far in debt that you’ve turned to debt settlement, your credit has probably already been trashed. ever thought of getting a second opinion?
A second hidden cost of debt settlement is that the money your lender agrees to write off due to settlement will be reported by your lenders to the IRS as ordinary income. This could affect your income taxes the following year although some lenders never report the money they’re written off and even if they do, it might not have that much of an impact.
A good and honest credit counselor will tell you if your situation is so bad that you need to file for bankruptcy. While a bankruptcy will have a dramatically negative affect on your credit history and your credit score, it is one way to get out from under a load of unsecured debts in an extreme situation. For example, let’s say that you earn $20,000 annually but have a cumulative credit card debt of $50,000 or more. In this case, bankruptcy might actually be your best option.