4 Ways Credit Counseling Can Hurt Borrowers

Credit counseling is supposed to be a resource for borrowers to reduce their debts. Unfortunately, it often has unintended consequences that can actually increase debt and stress for a borrower going through the process. Understand the risks of entering a credit counseling program before deciding on the option.

#1 Counseling Fees

No credit counseling is free. There are some nonprofit credit counseling services, but even these companies charge a fee. The for profit companies may be more effective at reducing a borrower's debt, meaning the exchange for higher fees when electing a for profit counselor may be worth the reward. Any way the situation comes to fruition, the borrower will end up paying a premium that can cut into the reduction of debt, making the service less effective. Since borrowers seeking credit counseling often have low liquidity, they may have to add any service fee to their ultimate payment plan. This means interest will be charged on the fee, making it even pricier.

#2 Extended Repayment Terms

Most credit counseling services will offer a borrower low monthly payments. This may seem too good to be true, and that is because it is too good to be true in most cases. Credit counselors can work out this deal because they use very long loan terms, perhaps extending repayment up to 30 years. Long loans disguise the actual cost. Borrowers may find they are not saving any money at all; instead, they are simply spreading out their debt over a longer period of time. It is important to factor in the total cost of both the current debt situation and the plan after counseling to understand if it is a viable option. Unfortunately, many credit counseling services do not offer a total cost up front, making this comparison hard to complete. 

#3 Credit Score Problems

A borrower seeking credit counseling is likely deeply in debt and possibly nearing default on multiple loans. This borrower is in a compromised credit position. Any borrower who thinks entering counseling will resolve his credit issues is not understanding the situation. When a borrower uses a credit counseling service, she is likely settling, consolidating and refinancing multiple debts. The lender who issued the original loan contract will not look upon this favorably. That lender, and likely multiple lenders in most situations, will provide a negative report to the credit bureaus. When these reports hit all at once, a borrower will see a score drop several hundred points.

#4 Bankruptcy Postponement

Many borrowers think credit counseling is preferable to bankruptcy. It is, but only in some situations. In others, when a borrower qualifies for bankruptcy, it may be a better strategy to use the protection. Bankruptcy can eliminate debts without additional financial consequences. Though the borrower will have to liquidate assets and lose credit, the borrower may find more relief with this option. This is particularly true if the borrower will not be able to meet the demands of the new credit management plan. In this case, credit counseling is just a postponement of bankruptcy. 

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