Wikipedia defines credit counselling as “a
process that is used to help individual debtors with debt
settlement through
education, budgeting and
the use of a variety of tools with the goal to reduce and ultimately
eliminate debt.”
In some
countries it is a mandatory process before anyone can file for
bankruptcy. Different countries have different regulation for it.
Credit counselling agencies can be not-for-profit, no fees entities
or they can also be for-profit, charging very high fees.
The credit
counselling works on a three step approach.
First Step : Evaluate the current credit health status
Second
Step : Draw a personalized plan on resolution and to increase credit score
Third
Step : Implement the plan and evaluate on a regular basis
The first
task of any credit counselor is to understand the individual
financial situation. It is thus important that the debtor should not
hide any fact from counselor. Most debtors come with multiple loan defaults, very low credit scores and no income source to payback the
loans. In such a distress it is counselor's job to first give
confidence to the debtor and understand the complete picture.
Next the counselor tries to chalk out a plan for repayment, settlement and
negotiations. A debtor may here authorize the counselor to negotiate
with creditors on his/her behalf. Counselor then tries to discuss debtor’s situation with lenders and tries to get the best possible
solution, whether it is a waiver of interest amount (partial or
full), an extension for payment duration or settlement through
partial payment.
During this
time, the counselor also educates the debtor about the various
rules, regulations and personal finance management techniques through
which the debtor can plan for payments as negotiated and avoid
getting into similar situation again.
Finally the counselor may also suggest a debt management plan (DMP) to the
debtor. Herein, the debtor legally hands over his/her financial
liabilities to the counselling agency and makes monthly payments to
them, which the agency then re-distributes among lenders as per
negotiated terms. It is important to note that while DMP may seem
like an easy solution, it costs money and involves sharing your
sensitive personal information with the counselling agency.
Does credit
counselling affect credit score?
A counselling
session by itself will never affect your credit score, but if you
take a DMP, it may affect your credit score negatively in the short
run. Because, first, it usually involves paying off debt accounts and
closing them one after another. Second, a loan settlement or partial
payment will again negatively affect your credit report. Lastly, if
the agency stops making payments on your behalf it will further
damage your credit history. But a debtor who needs DMP may already
have a bad credit score due to bad financial history and hence in the
long run it only helps close all bad debts and start afresh.
Things to be
careful about
It is
important to take credit counselling if you are in deep debt and
don’t have sufficient resources to close the debts. But it is also
important that you select your credit counselling agency carefully.
Always select a reputed and authorized agency and beware of those who
upfront ask for large fees or sensitive personal information.
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