What is credit counseling, and how can it help you?

My readers know that I often suggest credit counseling to help them get a handle on financial problems.

A nonprofit credit counseling agency serves as an objective resource to help you see your situation dispassionately. It can offer individualized solutions for resolving your credit and debt issues. This is particularly useful in difficult-to-understand situations such as:

• Mortgage defaults: The rules are complex, the dates inflexible and the servicers often ineffective. A HUD-certified credit counseling agency (not all are) can lead you through the intricate process and may help get you special access to decision makers.
• Multiple collection accounts: Conflicting demands from multiple collectors can make it impossible to come to terms with all of them.
• Joint credit issues: While they are not marriage counselors, an outside dispassionate point of view can help you find clarity and a solution.
• Bankruptcy: Credit counseling is required by law as part of the bankruptcy process. A counselor can help you understand what really happened and avoid those issues in the future.

Let’s dive a little deeper into this industry this week and answer some questions you may have.

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What does a credit counselor do?

First and foremost, a credit counselor will give you a comprehensive analysis of your entire financial situation to help you come up with the best solutions for you. Secondly, a counselor recognizes that whatever plan is ultimately recommended it has to work for both you and your creditors.

No, this doesn’t mean that they work for the creditors. They work for you. But the reality is that creditors have certain rights and remedies, and you have taken on certain repayment obligations when you turned the credit they gave you into debts that need to be repaid. Coming up with a workable solution that benefits both parties while trying to preserve your credit is the Solomon-like task these nonprofits have taken on.

A good counselor is going to want to know how much money you take home, how much money you spend and how much money you owe. While this may sound pretty simple, not everyone knows these basic facts.

While your rent and your car payment will probably be easy to spell out, how easy will it be for you to recall how much your car registration tags cost you every year? Do you know (or at least have a pretty good idea) how much you spend annually on birthdays and holidays? How about car maintenance? Going out to eat?

Anything you spend money on is going to be important to help your counselor get a good idea of how much discretionary income you have to work with.

What to expect from a credit counselor

Your first call to a credit counselor could be as long as an hour to an hour and a half because the best counselors will want to make sure that you and your creditors are a good fit, and that will take knowing details … lots of details. When it comes to your debts (like credit cards), your counselor may want to get your permission to pull your credit report.

This is not a requirement, but just so you know, it is a soft inquiry that will not have an impact on your credit score. However, it may save a little time in detailing your accounts with your counselor. For the rest, a great way to prepare for a call to a credit counselor is to review your expenses for a month.

Check your credit card statements, checking account statements and ATM withdrawals. The idea is to account for as much of your paycheck as possible. Even then, expect to get to only about 80%!

At the end of your initial consultation, your counselor will lay out your options. These may include referrals to additional resources, a debt management plan (DMP), a debt repayment plan with some debt forgiven or even bankruptcy. But it could also just involve suggestions for bringing in extra income or trimming your budget to bring it in line with your current income.

See related: How does debt forgiveness work? 

Does hiring a credit counselor hurt your credit?

The act of speaking with a credit counselor will not have any impact on your credit score, one way or the other. In fact, unless you choose to enroll in a DMP to manage your credit card debt, there is no way for anyone to know you are working with a credit counselor, unless you choose to divulge that information. Your credit score will not care one way or the other.

The only thing that might bring your score down is if the debts or credit cards you put on a DMP are still open. Most plans require that the cards be closed, and that will affect your available credit and your credit utilization, which is an important factor in your credit score. (This is why I recommend not closing cards even if you don’t use them very much.)

But the benefits of a DMP could be worth the initial hit you take, especially if you already have a history of late payments. A DMP is set up to get you out of debt in five years or less and requires regular monthly payments. That alone will improve your score if you have to take a hit at first, because on-time payments are the No. 1 factor in your FICO score.

When to use a credit counseling service

If you are struggling to make ends meet on a regular basis, a call to a credit counselor may help. Ideally, I would like to see you make the call before you become seriously delinquent on any of your accounts, as you will typically have more options available before you begin to default.

This is especially true of mortgages. Your first call will cost you only your time. You will very likely walk away with a better understanding of your financial situation and some valuable credit education.

But it is also never too late to give credit counseling a try before you move on to other, more drastic solutions (like bankruptcy) or just giving up.

I would suggest a call to a credit counselor that offers the bankruptcy certificate you will need before you make the final decision to file. If, after your consultation, you decide to move forward with the bankruptcy, you will have already met that requirement.

See related: What to do if bankruptcy is not an option

How much does it cost to use credit counseling?

Your first call is free. Bankruptcy certificates are usually about $50. If you choose to enroll in a DMP, you will be charged a small monthly fee and you may have to pay a one-time set-up charge.

These fees are regulated by your state, but monthly fees are typically $20 to $75 and set-up fees are usually $30 to $50 (though some can charge up to $75). However, one of the best things about a DMP – besides the stopping of collection calls – is the reduction in interest rates and the elimination of late and over-the-limit fees.

These reductions generally are much greater than any fees you are charged. That makes it a win-win in my book.

See related: How to avoid common credit card fees

How do you find a good credit counselor?

Everything I have said about credit counseling here relates to “the good guys” who are nonprofit and independently accredited with certified financial counselors. These are mission-driven professionals that will only act in your best interests (and not their own).

That being said, you can find one of the good guys at the National Foundation for Credit Counseling, the oldest credit counseling organization in the country, with almost 100 non-profit member agencies across the nation. You can also check out this article from the Federal Trade Commission to help you find a reputable counselor.

Remember to keep track of your score!