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Credit Counseling Overview

Many people get into debt for a variety of reasons. Sometimes it is due to overspending and lack of financial restraint. Other times, it may be due to unforeseen events such as a loss or reduction in income, layoff, accident, or medical bills. Regardless, it is likely that at some point in your lifetime, you may face a higher debt load than you are able to manage. When this happens, there are many different avenues you can take to reduce what you owe. Sometimes it's just a matter of cutting back and watching your budget. And on the other extreme, sometimes it takes a declaration of bankruptcy to clear all your debts and give you a fresh financial start.

In the middle of the spectrum lies credit counseling - the umbrella term given to a planned method of debt repayment under a plan known as a debt management plan coordinated by a credit counselor. Credit counseling aims to consolidate your unsecured debts like credit cards, store cards, medical bills, or utilities, into one, more manageable, and more structured payment plan.

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Credit Counseling: The Basics

Credit counseling is typically done by an individual or agency that negotiates with your creditors to establish a DMP, or Debt Management Plan on your behalf. DMPs usually offer the consumer reduced payments and lowered interest rates and fees, and credit counselors work with financially distressed consumers to come up with a workable and realistic plan for paying off debts on a predictable timeframe. For example, if the consumer's financial capability is only $100 a month toward debt repayment, the counselor will work with the creditors to establish a plan that meets this ability and payments will be made by the consumer to the credit counseling agency who, in turn, will distribute payments to each creditor that has agreed to become part of the debt management program.

One of the benefits of credit counseling is that all your monthly payments are consolidated into one monthly payment, and this sum is typically less than the total of the individual monthly payments. The reason is: most credit card companies believe that debts are more likely to be repaid under a DMP than if the consumer is paying them off on their own, and therefore they are more willing to accept lower monthly payments as a sign of good faith.

Beyond reducing your monthly payments, DMPs also may lower the interest rates assigned by your creditors. The main advantage to this is that by consolidating debts and pairing them with reduced interest rates, you can pay off your debts sooner than if you continued to only make the minimum payments at the higher-interest rates.

Impact to One's Credit Score

There is an assertion that exists today that participating in a Debt Management Plan can ruin a consumer's credit score - this assertion is true or false, depending on who you ask. According to the Fair Isaac Corporation, the company that created the FICO Credit Score, a DMP has no effect on your score. Then, there are consumer credit reports on which a DMP will show up and have a detrimental effect. Because of this, a consumer may have a more difficult time securing a loan for a home or car purchase, and may be denied further unsecured credit (such as additional credit cards).

While low-limit credit cards are usually approved after only a look at your credit score, banks determining whether or not to approve a loan will take the entire credit report into account. The presence of a DMP can signal an inability in a customer to responsibly manage his finances and may result in the loan being denied. So, in this instance, a DMP may not hurt your score in itself, in fact it can help you improve your score -- BUT simply having it noted on your credit report could have an impact on your ability to be granted new credit.

In addition, any mortgage loans backed by federal programs such as HUD or FHA have their own government underwriting guidelines that operate alongside a lender's own policies. Federal programs take a neutral stance on credit counseling, and insist that the most important thing they look for is if the consumer has been making steady payments into his or her DMP.

If you do decide to enroll in an DMP, be aware that some credit counseling agencies have received criticism for understating their client's responsibilities. There are documented cases in which agencies have told their clients, during the enrollment process, to stop paying their creditors directly - and then keep the first payment that would be made into the DMP to cover fees. If your accounts are already overdue and delinquent, this might be acceptable - but most people who enroll in a DMP don't have delinquent accounts - they are merely trying to lower their interest rates on existing accounts that are current. Stopping payment during the enrollment process would then be a very bad idea, because creditors can render these accounts past due - this leads to increased derogatory information on a credit score, making it that much more difficult to get to a state of cleared debt.

So let's recap.

Deciding you need the services of a credit counseling agency to help you manage or get your finances on track is NOT the sign of fiscal irresponsibility. Quite to the contrary, it reflects acknowledgement on your part that you want to be in better standing with the credit bureaus and you're willing to take the appropriate steps to get there.

When you think you might be ready to enroll in a DMP, explore your options. you are wise to identify a reputable debt consolidation agency that can truly help you reduce your monthly payments and help you to get back in control of your finances and work towards a predicable debt free day. In the process, considering the money you may save via lower interest charges, credit counseling could indeed save you money and, if you take a more disciplined approach to credit in the future, get you off the debt treadmill once and for all!

Congratulations for exploring information and steps to gain control of your finances and working towards the goal of becoming debt free!

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