Editor's note: This article is an excerpt from A Survival Guide to Debt by Mitchell Allen.

You’ve probably seen the ads on TV:

  • "We can cut your credit card debt in half..."
  • "Get your life back; call this toll-free number..."
  • "X-Y-Z Debt Consultants made the harassing calls stop..."

Over the last few years, right along with banks' aggressive credit marketing and the resulting mushroom of consumer debt, we have seen a dramatic growth in the number of companies advertising themselves as debt consultants, debt negotiators and other titles signaling that they offer debt relief alternatives to people who find themselves in over their heads.

As with any growth industry, the debt settlement and negotiation business has its share of the good, the bad and the ugly. Once you decide that this is the route you want to pursue, you still need to be careful and exercise discernment. In other words, you shouldn’t call the first toll-free number that appears on your television screen or sign on the dotted line based on a quick sales pitch. A good debt settlement, credit counseling or debt negotiation firm can definitely help you work with creditors to improve your financial situation. However, as with any scenario involving large sums of money and desperate individuals, there are plenty of unscrupulous operators out there who are perfectly willing to take your money and not give you any of the help that they’ve advertised. That’s the last thing you need. So… how do you tell the difference between the quality firms and the sleazy vendors? Keep reading.

Credit Counseling: The Traditional Favorite

Credit counseling in the United States began in the early 1950s, during the post-war economic boom. With the dramatic increase in lending that powered the expansion in home construction and other consumer lending, creditors and lawmakers recognized a need for an organization that could advocate for the credit-granting industry and also work with consumers who needed assistance. The National Foundation for Credit Counseling (NFCC) was created in 1951, and the first local credit counseling franchises began operating in the early 1960s, providing financial education and credit counseling to consumers. In addition to the NFCC, the principal industry organizations for consumer credit counseling firms are the Association of Independent Consumer Credit Counseling Agencies (AICCCA), founded in 1993, and the American Association of Debt Management Organizations (AADMO).

At the very least, any credit counseling or debt management organization that you consider working with should be a member of one of these trade groups. Since the credit counseling industry was essentially the idea of lenders and since lenders still provide the primary financial support for credit counseling firms (more on this later), it should come as no surprise that the principal objective of most credit counseling firms is to enroll you in a debt management plan (DMP) that will eventually result in the full repayment of your debt.

So what’s the advantage to the consumer? For starters, when you enroll in an approved DMP with an accredited credit counseling agency, the collection calls will stop. The agency will contact your lenders to inform them that you are enrolled in a debt management plan and are in the process of satisfying your debt. As long as you fulfill the terms of your DMP, including making timely payments for the typical five-year term, the collection calls will be halted.

Next, once you enroll in credit counseling and begin making timely payments within your debt management plan, your past-due accounts will often be re-aged. This means that the lender will agree to remove late payment notations from your credit record and, as long as you remain in good standing with your DMP, you’ll end the process with a cleaner credit report. Note that re-aging the account does not remove negative entries that originated from the period prior to enrollment in the DMP, but it does give consumers the ability to get a fresh start and begin rebuilding a good credit record. While your credit counseling history will be on your report, it will also show your successful completion of the DMP.

Finally, since all of your debt is usually consolidated into a single payment under the terms of your DMP, you gain the simplicity of a single monthly payment rather than multiple payments to different creditors. Not only that, but the payment is often less than the sum of your former payments. One reason for this is that since the credit counseling company essentially works for the banks issuing the credit, lenders will accept lower payments from consumers who are enrolled in a DMP. The other reason is that credit counseling agencies are usually able to get your interest rates reduced, not only allowing more money to go toward the debt’s principal balance, but also decreasing payments overall.

"Nonprofit" Does Not Equal "Charity"

You may be wondering what the downside is. You get a lower monthly payment and lower interest rates, the collection calls stop and you're able to rebuild your credit record. What’s not to like? Not only that, but since most credit counseling organizations are set up as nonprofits, it seems as if there should be very little risk or worry for consumers, as long as they maintain their debt management plans in a timely manner.

But let’s take a look at that term: nonprofit. Just because credit counseling firms are typically set up as nonprofits does not mean that they don’t make money. As a matter of fact, many credit counseling firms are wildly profitable; they simply make certain that instead of paying dividends to shareholders or contributing profits to owners, they plow all funds received back into the company. This can include buying top-of-the-line equipment, renting plush office space and paying generous salaries. So where, you may ask, does all that money come from? Great question.

  1. First of all, credit counseling firms receive consumers' payments on their DMPs and forward those funds to the issuing lenders—a portion called the "fair-share payment," which stays with the credit counseling agency. In other words, the lenders, in essence, are paying the credit counseling firms a fee to collect and distribute payments from consumers. Formerly, fair-share payments were around 15% of the amount collected, but in recent years, payments have reportedly fallen into a 4–10% range.
  2. Next, credit counseling firms can collect upfront fees from consumers. While agencies affiliated with the NFCC—usually designated as Consumer Credit Counseling Services (CCCS)—typically charge a nominal setup fee of around $10, some agencies can charge significantly more. Obviously this money, rather than being used to satisfy creditors, goes straight to the agency’s bottom line.
  3. Finally, non-profit credit counselors may solicit voluntary donations from consumers who are enrolled in DMPs. These contributions are reportedly to be used to defray costs associated with setting up and administering DMPs, and providing credit and financial counseling, according to the terms of the organization’s nonprofit charter. However, some consumers have reported difficulty in extricating themselves from these so-called voluntary programs. To discourage consumers from ceasing their donations, some agencies may threaten negative credit reporting or even discontinuance of the DMP.

It may not come as a surprise that a number of state and federal entities have begun investigating the practices of many nonprofit credit counseling agencies. Some have had their nonprofit status revoked by the IRS and some state attorneys general. Among the complaints filed by consumers against these firms are high upfront fees, non-refundable or compulsory donations, failure to deliver promised financial counseling services and failure to provide implied benefits. In fact, some consumers have actually completed their debt management plans, only to discover that their credit score was lower than when they started! Obviously, such supposedly nonprofit credit counseling services are more interested in earning fee incomes from DMPs than providing the counseling and consumer-focused services that their names imply.

Finding a Reliable Credit Counseling Company

As I mentioned at the beginning, along with the bad credit counseling firms that have created problems for the consumers who worked with them, there are also many good organizations that deliver the services and benefits that they advertise. One way you can help yourself narrow the field down to some of the companies that are more worthy of your trust is by working only with agencies that are accredited by and affiliated with one of the principal credit counseling industry trade groups: the NFCC, the AICCCA or the AADMO. Take some time to browse each organization’s website to learn a bit more about it and to get a list of accredited and/or licensed credit counselors in your area.

Credit Counseling Code of Ethics

In order to maintain a good standing with its trade organization, a credit counseling firm must typically subscribe to and comply with a code of ethics or conduct in its dealings with consumers. Additionally, many states regulate or license credit counseling firms operating within their borders. Before you sign up with any credit counseling firm, it’s a good idea to ask if they have a written copy of their code of conduct or a web page from which it can be easily downloaded. Find out about your state’s licensing or regulatory requirements for consumer credit counseling (some states do not regulate or require a license for credit counselors), and don't forget about the counseling itself. Many consumers are so focused on getting out from under debt that they may forget one of principal reasons that credit counseling was developed: to provide sound financial planning and education for consumers to enable them to make better decisions in the future. Don’t be in such a hurry to ask about debt management plans and halting creditor calls that you forget to learn about the credit and financial counseling services that the firm offers. Most offer good to great material, so make sure to ask them about what they have to offer and take advantage of it.

Keep in mind that the whole idea of working through a credit counselor is to position yourself to make better financial decisions in the future. Otherwise, you’re wasting one of the best potential long-term benefits of the program. When you ask about the counseling services, pay close attention to the answer; if the representative seems at all disinterested or too eager to get you signed up for a DMP, take a step back. Reputable credit counselors place as much emphasis on providing consumer education as they do on collecting your money and forwarding it to creditors.

Check Credit Counselor's Reputation

You wouldn’t go to a restaurant that had a reputation for bad food or lousy service, would you? The same principle applies to choosing a credit counseling firm. One way that you can get an idea of the company’s reputation is by checking with your local Better Business Bureau (BBB). For one thing, any firm that you deal with should ideally be a BBB member. Also, any complaints filed against the firm will be a matter of record with the BBB. Your state attorney general’s office and local or state consumer protection agencies are also good places to check for information about negative experiences that consumers may have had with your prospective credit counselor. The National Association of Attorneys General has a website that you can use to get in touch with your state attorney general’s office.

If you do uncover complaints against a provider that you’re considering, don’t be afraid or embarrassed to ask about them. After all, you’re potentially placing a significant amount of trust in them with very important financial matters; they shouldn’t mind satisfying your need to know about their dependability. Besides, asking about the situation gives them the benefit of the doubt; it signals that you understand that there are two sides to most stories. By listening to their side, you demonstrate the same sort of fairness you’d expect from them in their dealings with you.

What about the Fees?

Everybody knows that there’s no such thing as a free lunch. Still, you have a right to know, before signing up for anything, how much you will pay for the services that the credit counselor is providing.

  • How much of your monthly payment into the debt management plan will go toward satisfying your debts, and how much will go to the credit counselor?
  • Are there setup fees? If so, how much are they?
  • Are there any other fees, contributions or payments expected of you as a part of the program?
  • How are program fees calculated?

Remember, this is your money, and you have a right to know the answers to these questions. Ask for a printed schedule of fees and the services they pay for.

Some Additional Cautions

Just because you enroll in a debt management plan with an accredited or licensed credit counselor, you can’t shift all further responsibility for your situation onto your credit counseling firm. First of all, if you do decide to enroll in a debt management plan, it should be because you and your credit counselor have carefully examined your situation and determined that a debt management plan really is the best way for you to get your debt settled. DMPs are not the only alternative, however, and if you get into one, you need to be satisfied—on the basis of a sound analysis of your situation—that a DMP is the best way for you to go.

Most DMPs are set up on a five-year term; this has advantages and disadvantages. The main advantage, from the perspective of most consumers, is that the five-year term allows for smaller monthly payments, allowing a bit more breathing room in the month’s cash flow. The principal disadvantage is that such a long payout often proves difficult for many consumers to complete. If they are unable to maintain the payment schedule until completion of the DMP, they often find themselves right back in the same situation where they entered credit counseling to escape—or worse.

Another thing to keep in mind is that credit counseling firms, as noted above, get most of their money from the banks that issue credit cards and other forms of consumer debt. If you are in credit counseling, you will, in most cases, pay back 100% of the debt that is enrolled in your DMP. For consumers struggling with a heavy load of both secured and unsecured debt, this can prove difficult or impossible. There are other options that do not require 100% payback. Some credit card companies, for example, will offer a partial payback as a settlement option in cases of demonstrable financial hardship. This is one reason why you should not automatically assume that a DMP is the best way to settle your debt.

Keeping Your Counselor Honest

If you do enroll in a DMP with an accredited or licensed credit counselor, you should not only commit to making your monthly payments on time and in full, but also to closely examining your monthly statements to be certain that your payments are being applied to your debt and that the agreed-upon communication between your credit counselor and your creditors is taking place. Some consumers have complained that because of the timing of payments from the credit counselor to the creditors, they continued to accumulate late payments or other negative credit notes on their credit histories, even though they paid into the DMP on time each month. This is where your personal responsibility for your situation comes into play. Don’t defer responsibility to your credit counselor, even if the company has an excellent reputation. Those statements are provided to you for a reason, so read them!

Here’s another important note: be sure that your credit counselor provides you with proof that your creditors have accepted your DMP. It seems obvious, but unless a creditor agrees that your performance of the terms of the DMP is an acceptable way for you to satisfy your obligations, your payments into the DMP will not make any positive difference on your credit report.