Credit Counseling Companies Offering Nonprofit Debt Settlement

For many years, debt relief plan providers, such as nonprofit consumer credit counseling and debt settlement companies, have been seen as separate and distinct from each other in the debt relief services industry. In fact, these two sides of the industry have often been at odds with one another. While debt settlement providers have never come together as a unified voice to slam the debt management side, credit counseling agencies have frequently come together (and acted individually), to vilify the concept of debt settlement itself, and later, to call out what they see as bad business practices found throughout the debt settlement side of the industry.

Both credit counseling agencies and debt settlement companies get it wrong when marketing debt relief.

What follows focuses mostly on the aspersions nonprofit credit counseling agencies lob at the other side while they actively (yet quietly), attempt to carve out a niche for themselves that would enable them to offer “Less Than Full Balance Plans” or “Credit Solution Plans” – which is just word play for their offering debt settlement.

I have been publicly critical of some of the same debt settlement company business practices that consumer credit counseling agencies have raised issue with. I am just as concerned with problem areas with the nonprofit styled quasi debt settlement programs and the credit counseling groups who offer them, as they attempt to break into servicing debt negotiation plans.

Credit counseling companies working with people who are struggling to pay their bills, have been limited to offering debt management plans (DMP’s). It’s traditionally been the only tool in their tool box. The debt management program implementation is how they make revenue from both the consumer on a monthly basis (monthly servicing fee), and from participating banks that offer charitable and tax deductible fair share and grant contributions as a benefit for enrolling and managing the banks collection functions. Credit counseling has continued to lose relevancy.  There are a bevy of reasons for the loss of effectiveness of credit counseling agencies in the market place. Here are just two:

• Banks offer debt management plan styled hardship repayment plans direct to their own customers in direct competition with credit counseling companies. Some reports suggest that the larger credit card issuing banks have twice as many people they themselves enrolled into internal hardship plans than they have from consumer credit counseling services.
• The recession and job market has created a situation where a debt management plan (which is designed to offer the struggling consumer monthly payment reduction through interest rate reduction), is not enough relief for many people to continue to make timely payments. In fact, due to the rigid payment structure of the DMP, more people fail out of the plan than complete them.

While there are more concerns to list as credit counseling companies fight to maintain a position in the debt relief services market, the two highlights above will also impact the sector if they break into the debt settlement market. The current iterations of less than full balance plans that would be administered by credit counseling agencies would likely suffer poorer efficacy and completion rates.

Debt management plans administered by nonprofit credit counseling agencies.

These nonprofit agencies are not, in my opinion, typically operated as charities, but as businesses (with some limited exceptions). These organizations rely on the monthly contributions they receive from consumers who are enrolled in debt management plans. The average monthly payment consumers make to a credit counseling company for administering a debt repayment plan is roughly $30.00. This average accounts for consumers who pay a higher amount and people whose monthly fee to a nonprofit credit counseling company is cut to zero due to plan affordability. CCA’s then rely heavily on charitable donations from the very banks they are remitting payments to on behalf of their customers.

The donation funding from banks have been severely cut across the board over the last several years.  Even with these cuts, bank donations are still a significant portion of nonprofit agency revenue.  So much so that many credit counseling agencies cannot envision getting by without the banks support were this side of their revenue cut entirely.

Debt settlement works, in large part, due to the flexibilities it affords the struggling consumer.

Here is what a debt settlement plan (aka less than full balance and credit solutions plans), looks like for the bank, the nonprofit debt repayment agency and the consumer:

Individual qualifications for one of these credit counselor sponsored repayment plans will be set up using criteria similar to debt management plan qualifications. There will be credit score, discretionary income and monthly cash flow modeling.

Debt management plans already experience high failure and drop out rates due to; narrow and strict qualifications; combined with the inflexible payment amounts that don’t allow customers to prepare for emergencies; and the fact that financial setbacks happen to people enrolled in the plans.

The less than full balance criteria will inevitably follow a similar pattern of narrow guidelines and will suffer from the inflexibility purposefully created in the system. So, rather than flexible debt settlement plans tailored and applied to the proper set of individual circumstances, the credit counseling agencies less than full balance plans are bastardized at the expense of the consumer for the benefit of the nonprofit agencies so they can maintain revenue and relevancy.

Debt solution plans are supposed to solve a persons credit card payment concerns.

Creditors are required to charge off non performing accounts by following GAAP. Charge off of accounts that are not being paid the minimum due in a timely way are treated as liabilities and must be offset against loss reserves in a prescribed period of time. Banks will charge off accounts entered into these agency plans earlier than customary or on schedule (generally 180 days of consecutive missed payments). Debtor’s credit scores will get hammered immediately when enrolling in these plans. This is a byproduct of settlement plans and should be expected. No big deal right? Wrong. The full balance of the debt owed will still be reported while making payments in the credit counseling version of debt settlement. The actual settlement will not be updated to the consumer credit report until the final payment is made. If the “less than full benefit” to the consumer plan runs 48 to 60 months, the individual credit report gets hammered up front; the poor debt to income ratio is maintained throughout the entirety of the plan; and the credit gets hammered anew at the end of the plan due to the fresh negatives of settlement being reported 4 and 5 years down the line. This will prevent people from accessing credit markets for:

•  home purchases
• refinancing
• student loans for themselves or cosigning for children
• auto loans
• and other credit products.

Where credit reports are used as a pricing mechanism for insurance products etc., this type of plan will assure maximum premiums are paid for the longest period of time.

When plans for settlement of unaffordable debts are created specific to the individual’s situation, credit reports and scores can recover sometimes within a year or two (similar to availability of credit to chapter 7 filers). These “less than fully beneficial” plans being contemplated by credit counseling organizations will cause a doubling or tripling of the negative impact to credit reporting and access to certain types of credit products while being extolled as being helpful.

Additional concerns with the credit counseling agency version of nonprofit debt settlement.

There are tax implications when satisfying a debt obligation for less than what was owed.If more than $600.00 is forgiven in an agreement to settle debt, the amount forgiven is deemed income by the IRS. Settlement companies have to disclose this. Credit counseling agencies will too, but for years now, CCA’s have pointed to the tax implications in a debt settlement plan as the reason to avoid them. They rarely pointed out that the IRS allows consumers to apply a solvency test in order to avoid the tax implications when settling debts for less. They will have to change their tune when offering the less than full balance option.

There are problems with how the tax issue can be managed in one of these “light on benefits” plans. In a flexible and strategically creative settlement plan, debts can be settled in multiple calendar years in order to better plan and budget around the tax that may come due for people who are solvent. With less than full balance plans, those taxes will likely all come at the same time at the end of a 4 or 5 year plan. People who are unable to maintain the minimum required payments on credit cards are experiencing a financial hardship at that time. This increases the likelihood they will be able to fully or partially benefit from the solvency rule and limit the exposure to paying taxes associated with forgiven debt. But given 4 or 5 years to recover while on a nonprofit credit counseling agencies less than full balance plan (for those who are able to complete one), people will likely be lead to a sizable increase in taxable income in the following year – after their credit card debts were finally considered settled. This could add another a year or more to a pinched household budget , or even a much more debilitating outcome.

Many credit counseling companies have poor customer retention with their DMP’s.

There are certainly talking points to distract people from the reality of the high attrition numbers for DMP’s, but those same points will not play well with the dropped and canceled files in a “Credit Solutions Plan”. In a DMP, the creditor offers to re-age accounts and lower interest rates while the DMP notation for each trade line enrolled appears in the credit report of the consumer. The DMP notation is removed when the plan is no longer being implemented. In the LTFB, when the consumer drops the plan, the damage created cannot be unwound. The charge off that occurs at the time of enrollment sticks and all benefits are lost. The full balance of the debt remains and there could be penalties and fees assessed anew (perhaps even retro actively). credit counselors will have to disclose all of these issues upfront to the consumer, but people will forget what they were told and what they read and agreed to later on. It’s a certainty.

CCA’s will be exposing themselves to private right of action claims they cannot possibly think of right now. Banks may be pulled into litigation as well. The LTFB plans may create a situation where some state laws that prohibit an account be placed in a negative amortization situation will be breached by people who enroll and drop out in the first several months. This is only one area where state laws and the plaintiffs bar will potentially take action. This same circumstance probably exists now with credit counselors who enroll customers into DMP’s where the customer drops the plan after making only one or two payments, but to a far lesser degree than would be likely in the same circumstance with nonprofit debt settlement plans offered to less than suitable candidates.

Will credit counseling agencies disclose to people that they can settle their own debt for less?

In many instances, settlements will be available for far less. To not disclose this fact will certainly be creating litigation exposures. Banks will be pulled into these actions, I am sure. The nonprofits will create an additional conflict of interest when reducing their relationship with their customers down to one of acting as a fiduciary to the clients they enroll.

Consumers enrolling into the quasi debt collection scheme of a less than full balance/credit solution plan, who are unable to complete it, do not receive the benefit and protection of laws and rules that govern debt settlement service provider’s business practices today. Recent state and federal laws have been enacted to prevent financial harms to consumers. Settlement companies cannot charge for a service until they have performed it. With the credit counseling agency plans to offer a settlement solution outlined above, consumers who pay into the plan that are later unable to continue, will be damaged. They will have lost time and money applying a strategy that, when it fails, will find them worse off than before they enrolled in it. In several ways, I can see where the damage will be worse than the upfront fee debt settlement business models that were recognized as so very problematic by regulators and consumer advocates around the nation. Credit counselors may be unwittingly creating a situation where their campaign against debt settlement companies comes back to haunt them in a big way.

Banks continuing to offer reduced monthly payment options directly to their credit card members.

The larger credit  issuers already offer hardship re payment plans that often exceed the benefits consumers receive from a credit counselor sponsored debt management plan. Bank of America (BofA), JP Morgan Chase (Chase), and Citi Bank make up an estimated 65% of the credit card issuance in the nation. These large banks already offer balance reduction (debt settlement) and term payment arrangements to their customers prior to, and after charge off. Even if the Chase, Citi and BofA play ball with the credit counselors in a LTFB strategy, they will likely still offer the same plans to the consumers directly. Credit counseling will be competing with their financial service industry partners and exposing themselves and the banks to increased risks along the way.

The realities highlighted above are each worthy of more detailed commentary. I may cover them in additional articles.

Debt settlement is a flexible and rapid way to resolve credit card debts.

A good debt settlement plan puts the consumer in a position to return to responsible spending within 18 to 24 months. The demographic of those who cannot/should not enroll in a debt management plan, but are suitable candidates to avoid bankruptcy through a debt settlement plan, should be looked at as a large subset of people who can have stimulating impacts on the nation’s economy. Those who can return to responsible spending through chapter 7 discharge or settling unaffordable debts (as opposed to stringing out payments in a DMP, chapter 13, and poorly devised less than beneficial settlement plan), will assist in job creation and economic recovery. This is not an insignificant number of people. The numbers are in the millions.

The current efforts of the nonprofit credit counseling associations and debt management companies are not the way to go. They will lead to little consumer benefit and a fair amount of unintended consequences. I fail to understand why the less than truly beneficial programs are being designed the way they are by people who should know better. Credit counseling is trying to create a delivery system for a debt settlement option that fits within their collect and pay business model and the laws that govern them. They are trying to figure out what they can do to keep monthly costs of 5 to 10 dollars per customer enrolled in a debt management plan static with less than full balance plans they can administer. In these efforts, I cannot figure out where consumer benefits come into consideration. I see customer detriments instead. The engineering of the plans appear to first consider what credit card issuing banks will sign onto, followed by what CCA’s can fit within their current operational limitations, followed by any benefit to the consumer. This is all too evident, and it is “bass-ackwards”.

Most of the mid to larger sized credit counseling companies have a fantastic infrastructure and consumer reach. I have been very supportive of the fact that nonprofit debt management companies should have a debt settlement product/tool available to consumers. CCA’s who are unable or unwilling to build out internal resources should work with other legitimate providers who embrace the educational mission of the nonprofits. There are answers and options for credit counseling agencies to pursue in order to offer a legitimate debt settlement tool. The current iterations of less than full balance and credit solution plans miss the mark. I certainly hope this can stimulate a discussion with anyone concerned about debt relief services that benefit consumers, the economy, and the nation as a whole.

I care about this kind of industry shift. There is much more to it than what I have outlined above. If you have your own thoughts and concerns please post them in the comments below. This type of thing is best discussed in the open.