Credit Counseling and Debt Management Plans Explained

What credit counseling is

According to the CFPB, credit counseling organizations advise you on money and debts, help you build a budget, set up debt management plans and offer workshops. They are usually nonprofits, and their counselors are typically certified and trained in consumer credit and budgeting.

A good first session is mostly about listening and analysis. The counselor reviews what you earn, what you spend and what you owe, and talks through options. A debt management plan is only one of those options, and it is not right for everyone.

How a debt management plan works

In a debt management plan, often shortened to DMP, you make one monthly payment to the counseling organization. The organization then pays each of your creditors for you. Per the CFPB, a plan typically lowers your monthly payments and can reduce interest charges and fees.

A plan usually covers unsecured debts such as credit cards and personal loans. It does not usually cover secured debts like a mortgage or car loan. Creditors have to agree to the arrangement, which is why the organization's relationships with creditors matter.

What it can cost

Counselors may charge fees for some services, and some organizations charge setup or monthly fees for a DMP. The CFPB advises asking for a specific price quote in writing. Being a nonprofit is a good sign, but it is not a guarantee of low cost or good service, so judge each organization on its fees and conduct.

Compare the total cost of a plan, including fees, against what you would pay on your own. Ask whether the organization will help you if you cannot afford its fees.

Questions to ask before you enroll

The CFPB suggests asking any counseling organization the following.

• What services do you offer, and how are they delivered?
• Do you offer free educational materials?
• What are your fees, and will you help me if I can't pay them?
• Will I have a written agreement, and what are the counselor's qualifications?
• How are your employees paid?
• Can you provide references from past clients?

Red flags to watch for

Not every agency is reputable. The CFPB lists warning signs that should make you walk away or at least look more closely.

• Pushing a debt management plan as your only option before analyzing your finances.
• Charging for information.
• Requiring you to give details about your situation before sending free information.
• Paying employees more for enrolling you in services or taking fees.
• Promising unrealistic savings or results.

How to find a reputable counselor

The CFPB suggests starting with the Financial Counseling Association of America, the National Foundation for Credit Counseling (NFCC) and the U.S. Department of Justice's list of approved credit counseling agencies. It also recommends checking that an organization is reputable with your state attorney general or state consumer protection agency.

The NFCC's helpline is 800-388-2227. Whichever organization you choose, remember that you are in charge. Take your time, compare more than one, and do not sign anything you do not understand.

When a plan may not be the answer

A DMP asks you to commit to regular payments, often over several years, so it only works if your income can support the monthly amount. If your debts are far beyond what you could ever repay, a counselor may talk through other routes, and a bankruptcy attorney can explain bankruptcy. If a collector is already pursuing you, read our guide to your rights when a debt collector contacts you.

If you are only slightly behind, simple steps may be enough: contacting creditors, asking about hardship programs and rebuilding a budget. Our guide to building an emergency fund can help you avoid falling behind again.

What happens in a first session

A first session usually starts with a review of your finances. Expect to be asked about your income, your regular expenses and a list of your debts with balances, interest rates and minimum payments, so it helps to gather recent statements beforehand. The counselor builds a budget with you and checks whether there is any money left over each month to put toward debt.

From there, the counselor explains your options. These can include simply staying on top of your payments with a tighter budget, negotiating directly with creditors, enrolling in a DMP, or looking at other legal options if the debt is too large. A trustworthy counselor will explain the pros and cons of each, including the ones that do not earn the organization any fees, and will not rush you to decide on the spot.

Take notes, ask for everything in writing, and take the paperwork home. If you feel pressure to sign immediately, that is a reason to pause and get a second opinion from a different organization.

Doing it yourself first

You do not always need an intermediary. Many creditors will discuss hardship options directly, such as a lower interest rate, a temporary reduced payment or a waived late fee, if you call before you fall far behind. Keep a record of who you spoke to, what was offered and any changes you agreed to, and ask for confirmation in writing.

The advantage of a DMP is structure: one payment, a set timetable and a counselor who deals with your creditors. The advantage of going alone is cost. Weigh both against how disciplined you are with a budget and how many creditors you have to coordinate.

Effect on your credit

The CFPB page we reviewed does not describe how a DMP affects your credit, and the effect depends on your accounts and the plan's terms. Ask the counselor directly whether your credit cards will be closed, whether accounts will be reported differently, and how the plan will show on your credit reports. Our guide to what makes up your credit score explains why on-time payments matter most.