Whither Consumer Credit Counseling?
Hunt, Robert M., Business Review (Federal Reserve Bank of Philadelphia)
For more than 50 years, nonprofit credit counseling organizations have been helping consumers manage debt. Despite this long track record, credit counseling is not without controversy. In recent years, concerns about conflicts of interest and the emergence of a new type of credit counseling agency have triggered significant legislative and regulatory activity. In this article, Bob Hunt outlines the history and development of credit counseling in the United States, highlights the concerns raised about consumer protection, and describes industry, regulatory, and legislative responses.
The availability and use of consumer credit in the U.S. has grown dramatically over the last 50 years. (1) While this is undoubtedly beneficial, one consequence is that, at any time, there are a million or more consumers having difficulties in managing their unsecured debts. For a half century, nonprofit credit counseling organizations have offered financial education and budget counseling sessions for free or at nominal cost to borrowers. They also negotiate comprehensive repayment plans (debt management plans) with a borrower's unsecured creditors. These repayment plans provide an alternative to bankruptcy that is valuable to many consumers.
But credit counseling is not without controversy. The older counseling organizations rely primarily on creditors for their revenues, and this may create the appearance of a conflict of interest. More recently, many new debt counseling organizations have appeared on the scene. This new breed relies less on creditors for revenues because they charge borrowers significantly more for their services. If these higher fees are drawn from a borrower's limited reserves, he or she may have additional difficulty completing the repayment plan. In addition, creditors worry that at least some of these new organizations are not screening their clients--proposing concessions for borrowers who could have paid their debts on the original terms. This has affected how creditors work with counselors. These concerns and others have triggered significant legislative and regulatory activity in recent years.
The credit counseling industry is an important one, but its activities and effects are not widely understood. Still the available research does give us some insight into the effects of consumer credit counseling and debt management plans on borrower behavior and the implications for the industry and regulation.
Any conclusions, unfortunately, must be tentative. There are few formal studies of the contribution of credit counseling organizations, and they must wrestle with a difficult methodological problem: Do borrowers who seek credit counseling perform better because of the counseling (a treatment effect) or because they are somehow different from borrowers who don't seek counseling (a selection effect)?
Credit counseling organizations typically provide four types of services to consumers: (1) they offer consumer financial education; (2) they offer budget counseling to individual households; (3) they negotiate debt management plans with creditors on behalf of borrowers; and (4) when appropriate, they refer consumers to other support organizations or recommend that they seek advice about a bankruptcy filing.
A debt management plan is a schedule for repaying all of the borrower's unsecured debts over three to five years. (2) Ideally, the credit counselor is able to include all of the borrower's unsecured creditors in the plan. While the principal is repaid in full, creditors typically reduce interest rates and other charges. Creditors are sometimes willing to re-age accounts in a debt management plan. In other words, assuming plan payments are made, the creditor considers the account as current and reports it this way to credit bureaus. This improves the borrower's payment history and credit rating.
An essential feature of the benefit credit counselors offer is the ability to coordinate the concessions made by a borrower's creditors. …