| How to wither consumer credit counseling (credit counseling)
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How to wither consumer credit counseling
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Credit counseling - Keep your debt in check
Before Hibbert Hill left for a study-abroad program in Australia last spring, he signed up for another credit card. One more wouldn't hurt, thought Hill, then a sophomore at Iowa State University. "I didn't plan on using [the card]," says Hill. "But Australia was a blast." The price tag? Over $10,000.
Luckily for Hill and others in his predicament--the average college student carries $2... Read credit counseling article
Bankruptcy Credit Counseling - What the Bankruptcy Law states
Bankruptcy credit counseling is a requirement of the new bankruptcy law effective October 17, 2005. The Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 requires court approved bankruptcy credit counseling to be completed by debtors prior to filing for bankruptcy within the 180 days immediately preceding the filing of a bankruptcy petition.
The new requirement for bankrup... Read credit counseling article
How to wither consumer credit counseling
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 credi- fetors 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)?
BACKGROUND
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. Of course, borrowers can negotiate with individual creditors, but they must overcome each creditor's concern that any concession it makes benefits the borrower's other creditors at its expense. Winton Williams coined a phrase for this phenomenon-the creditor's dilemma.3 All creditors would likely benefit if they all agreed to refrain from legal action and allow the borrower more time to repay. But if all creditors agree to this approach, any individual creditor might do better by insisting on being repaid from the proceeds of the concessions offered by other creditors. If creditors distrust each other, they will refuse to make concessions and possibly race to secure claims on the borrower's cash flow (by garnishing wages) or assets (by placing liens on the borrower's property). If this happens, the borrower is more likely to file for bankruptcy, and all the unsecured creditors are likely to recover very little.
Credit counselors can often avoid this outcome. Through repeated interactions with creditors, they have established a reputation for securing the agreement of most or all of a borrower's creditors and establishing repayment plans that put each creditor on more or less the same footing in terms of the borrower's resources. This reduces the risk of a run against the borrower, which, in turn, increases the chances the creditors will be repaid.
Note that participation in debt management plans is entirely voluntary. Borrowers need not seek a credit counselor, and they may abandon a repayment plan if they so choose. Similarly, creditors cannot be forced to agree to a debt management plan, and they are free to resort to collections activity or other legal activity at any time. Clearly, what makes these plans work, when they do work, is a good deal of trust that is fostered by the credit counselor.
Origins of the Nonprofit Credit Counseling Industry. The traditional nonprofit credit counseling organizations emerged in the 1950s and 1960s, partially in response to the rapid growth in unsecured consumer debt during that time. Many were organized by or with the support of creditors. During this same period, many states enacted legislation to regulate or simply ban the operation of the existing for-profit debt counselors (sometimes called debt poolers or proraters) on consumer protection grounds. Most states deliberately exempted nonprofit counseling organizations from these laws in the hope that they would continue to develop.4
A national trade organization, what is now called the National Foundation for Credit Counseling (NFCC), became active in 1951. At its peak, NFCC membership included about 200 organizations with about 1,500 offices around the country.5 Today, NFCC member organizations counsel 1.5 million borrowers each year. They administer nearly 600,000 debt management plans, which pay unsecured creditors at least $2.5 billion a year. To put these numbers into perspective, very roughly speaking, each year NFCC member agencies counsel about 1 percent of American bankcard holders, and there is one debt management plan for every two personal bankruptcy filings.
These nonprofit credit counselors rely primarily on contributions from creditors for their revenues. Under a norm called fair share, creditors would return to the credit counselor about 12 percent of debt payments it helped to facilitate. These contributions accounted for two-thirds or more of the revenues of traditional credit counselors, but the share has fallen in recent years.6 In the past, fair share receipts exceeded the cost of administering debt management plans, which afforded resources for the agencies' consumer education and budget counseling programs.
Some argue that a dependence on creditors for revenues creates at least a potential conflict of interest. For example, does a credit counselor that relies on fair share payments have an adequate incentive to suggest that a consumer seek legal advice about bankruptcy?7 About 6 percent of borrowers who contact an NFCC member agency are referred to legal assistance, while 30 to 35 percent are enrolled in a debt management plan.8 While these numbers suggest that counseling agencies might steer some borrowers away from bankruptcy, we need to know a good deal more about borrowers' circumstances and preferences to conclude that this pattern is inappropriate from the standpoint of borrowers or society.
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Credit counseling - Options and alternatives available to distressed borrowers
Why do borrowers enter into debt management plans? Why are unsecured creditors willing to accept these plans? The answer is that participating in the plans is better than the alternatives for some borrowers and their creditors (see Pros and Cons of Options Available to Borrowers). Depending on the resources available, borrowers can choose between repaying on the original terms, not paying but not filing for bankruptcy either (informal bankruptcy), and formal bankruptcy. Creditors can be either more or less aggressive in their collection efforts, or they may take legal action, such as obtaining an order to garnish wages.
One factor that influences borrowers' choice is the effect on their future access to credit. Obviously, timely repaymenton the original terms preserves the borrower's credit history and is most likely to ensure future access to credit on good terms. Under the informal or formal bankruptcy options, borrowers will have difficulty obtaining new credit on affordable terms for a long time. A bankruptcy flag remains on a borrower's credit report for 10 years.
Another factor that influences borrowers' choice is the size of the payments they make and how creditors respond. Payments are typically largest if the debt is paid on the original terms. Alternatively, the consumer can simply stop making payments (informal bankruptcy). But this option affords borrowers few protections from debt collectors. They can't prevent repossession of their car or foreclosure on their house. They can't prevent creditors from placing liens against the real property they own. They have few ways of avoiding garnishment of their wages. Still, many distressed borrowers choose not to repay and not to file for bankruptcy.9
Two Forms of Bankruptcy for Consumers. Most borrowers can choose between two forms of bankruptcy: Chapter 7 (liquidation) or Chapter 13 (a wage-earner plan).10 Both chapters impose a stay on collections and legal actions by creditors. In the case of Chapter 13, this may allow the borrower to catch up on mortgage payments and avoid foreclosure.
Under Chapter 7, the borrower's assets (except for certain exempt property) are used to pay some portion of the debts owed to unsecured creditors." The remaining unsecured debt is discharged, so the consumer's future income is unencumbered. In practice, borrowers filing under this chapter rarely have assets to surrender, so unsecured creditors receive little or nothing. The claims of secured creditors are unaffected, so they can eventually foreclose on those assets if they choose. It is not uncommon for borrowers to reaffirm their secured debts in order to retain the collateral (such as the car or the house).
Alternatively, the borrower can file under Chapter 13 of the bankruptcy code. Under this chapter, the borrower can keep his or her assets but must propose a repayment plan financed by a significant share of his or her future income over the next several years. The plan must offer unsecured creditors at least as much as they would obtain under a Chapter 7 filing, but, as noted above, this is typically not very much. Creditors cannot reject the terms of a plan if the borrower has pledged his or her entire disposable income over the next three to five years for debt payments. Disposable income here means income after taxes, basic living expenses, and tuition. Upon completion of the plan, the remaining unsecured debts are discharged. In practice, unsecured creditors typically receive a fraction of the outstanding principal (see below). General unsecured creditors received about $815 million from Chapter 13 plans during the 2001 fiscal year.12
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