That dreaded “B” word – bankruptcy. If it’s your worst financial nightmare, you’re not alone. Few things have as negative of an impact on your credit score than a declaration of bankruptcy, making options like debt settlement, debt consolidation, and credit counseling attractive alternatives for people in financial straits. But these options each pose certain risks, all of which must be weighed before taking an action that could remain on your credit record for the next decade.
Consumer Credit Counseling
What is consumer credit counseling, and how do these types of services differ from declaring bankruptcy? There are many different forms of credit counseling and each of them works a little differently.
- Debt Settlement allows you to negotiate the repayment of a portion of the money owed, after which the debt will be considered paid in full. Debt settlement firms can negotiate with credit card companies and other lenders to pay back less than the full amount of your debt, or to pay it back more slowly.
- Debt Consolidation is the process of combining all of your debts into one loan, arranged through a bank or a consumer credit counseling service. Debt consolidation makes it possible to lump all of your balances together at a lower interest rate, saving you money and allowing you to repay the debts more efficiently.
- Debt Management is a service offered by credit counselors in which a system is set up to help you pay back your loans and debts in the long run. This system does not actually change your debt; it simply combines your loans into one monthly payment to the debt management company, who then makes the individual payments to each creditor. This type of credit counseling offers the least benefit to consumers and is most conducive to scams.
Credit Counseling and Your Credit Score
While each of these credit counseling services does affect a consumer’s credit rating, it’s definitely a lesser evil than the black mark of having declared bankruptcy. Bankruptcy stays on your credit history for 7 to 10 years (depending on the type of bankruptcy filed) and may deter credit card companies, banks, and other lenders from doing business with you in the future.
Debt settlement can leave a negative mark on your credit history if credit card companies note that your account was settled for less than the full amount. Debt management can wreak havoc on your credit if the debt management company does not make payments in a timely manner (a common occurrence with these firms). This type of bad credit is usually easier to erase with smart financial behavior than declaring bankruptcy. Debt consolidation, on the other hand, does not affect your credit rating at all.
Is Credit Counseling a Viable Alternative to Bankruptcy?
The most important question, of course, is whether consumer credit counseling services can effectively prevent further financial problems and eliminate the need to file bankruptcy. The truth is that although legitimate credit counseling can help people, many who turn to debt management or debt counseling firms find that their situation is actually worsened rather than improved.
According to ConsumerAffairs.com, there is no federal regulation of debt counseling services, and only 17 states have specific regulations on consumer credit counseling – all of which makes this industry rife with scams and misguided, poorly trained financial advisors.
Debt settlement can be a big help to consumers who are buried in debt, but whenever possible it’s best for consumers to do the research and negotiate debt settlement with their own creditors. In addition to saving the sometimes hefty fees charged by credit counselors, this will also ensure that their money is going to the right place and that the debt really is being repaid. It’s probably best to avoid debt management firm’s altogether, as experts agree that these tend to be the most costly and least effective services. Debt consolidation can be a viable option, but make sure the payments are manageable and realistic before agreeing to a plan.
Debt counseling has clear benefits, but it remains a mostly unregulated industry, loaded with pitfalls that can trip up the people who are most desperate for help in regaining control of their finances.