Bankruptcy v. Credit Counseling
From time to time I get questions from potential clients asking about the benefits of credit counseling and whether they should be pursuing credit counseling instead of bankruptcy.
The attraction of credit counseling to people is they think that credit counseling doesn’t adversely impact their credit rating as bad as bankruptcy. Unfortunately, this is only partially true. Once a person is behind on payments, the person’s credit rating is already “ruined.” See my prior post last month when I discussed this issue of credit ratings.
A lot of these credit counseling companies claim they can negotiate deals with creditors to reduce your payments. Typically debt management programs offered by credit counseling agencies are only able to reduce interest rates. They can’t save you any money on the principal that you owe (of course this principal has ballooned because of past interest and late charges that are now part of the principal). Also, the fact that you went through credit counseling or a debt management program appears on your credit history and it does adversely impact it. Debt management programs typically offer 5 year payment plans where you have to pay the full principal balance plus interest (even if it is lower than the contractual interest rate and there are rare cases where debt management programs have successfully eliminated interest). Most people can’t afford those payments.
I always tell my clients that the first step to rebuilding credit once the credit report shows the delinquent payment history is to get out of debt. Of course, a Chapter 7 bankruptcy takes only about 3-6 months to complete and it involves paying nothing to any of the creditors. Also, a Chapter 13 bankruptcy can save you not only interest, but a significant portion of the principal balance on your debt. Thus, in my years of practice I don’t think I’ve ever seen a situation where credit counseling benefits someone more than filing either a Chapter 7 or a Chapter 13 bankruptcy.
Either a debt management program or bankruptcy adversely affects your credit. But, as I’ve said before, late payments and no payments also adversely affects your credit. Bankruptcy typically gets you out of debt quicker and allows you to rebuild faster than paying all of your debt back through credit counseling. Finally, it’s cheaper! You end up paying a lot less money, even factoring in legal fees.
