What is the difference between credit counseling and debt settlement, debt consolidation, or credit repair?

Credit counseling

Credit counseling organizations are usually nonprofit organizations that advise you on managing your money and debts. They usually offer free educational materials and workshops. An initial counseling session typically lasts an hour, with an offer of follow-up sessions.

Credit counselors can work with you to set up a debt management plan (also called a payment plan) for all your debts. They can’t erase your debts. Under a debt management plan, you make a single payment to the credit counseling organization each month or pay period. The credit counseling organization then makes monthly payments to your creditors. Credit counseling organizations are permitted to charge you fees for their services.

Under debt management plans, credit counselors do not always negotiate reductions in the amounts you owe. Instead, they work to lower your overall monthly payment. They might get the creditor to lengthen the time you have to repay a loan. They might also get the creditor to lower the interest rates. The arrangement usually does not affect your taxes.

Debt settlement

Debt settlement companies offer to remove your debts to lenders or debt collectors for a fee. They typically offer to pay off your debts with lump sum payments that you have to save up before a settlement. Under the law, money you save up in an account for use by a debt settlement company still belongs to you. The account must be administered by an independent third party and must be under your control. You are entitled to withdraw funds held in that account at any time without penalty. In practice, many debt settlement companies collect money from you and consider it fees you paid to them, instead of money they should be using to settle your debts.

Before you start working with a debt settlement company

• Many lenders do not negotiate with debt settlement companies.
• Many lenders and debt collectors do not negotiate a settlement amount for your individual situation—instead, they have standard policies about how much loan principal can be forgiven when you haven't made payments for a certain amount of time.
• Debt settlement companies usually can't get better terms than you could get by negotiating with your lenders and debt collectors yourself.
• Debt settlement companies cannot guarantee the amount of money or percentage of debt that you might save by using their services, and they cannot guarantee how long the process takes.
• Debt settlement companies cannot erase all your debts.

Beware of debt settlement companies that charge upfront fees. A debt settlement company could be breaking laws if they charge you a fee before three things happen:

1. A successful result is reached. The debt settlement company must have renegotiated, settled, reduced, or otherwise changed the terms of at least one of your debts.
2. An agreement is made between you and the creditor or debt collector. You must agree to the settlement agreement, debt management plan, or other result reached by the debt settlement company with your creditor or debt collector.
3. You have made a payment to the creditor. You must have made at least one payment to the creditor or debt collector as a result of the agreement negotiated by the debt settlement company.

If you simply cannot afford to pay what you owe, you could consider filing for bankruptcy. Consult a bankruptcy attorney to find out more about how this process works.

Debt consolidation lenders

Debt consolidation loans can be offered by banks, credit unions, and other lenders. A debt consolidation loan is money you borrow to repay all your separate loans and pay back just one amount. You pay back the debt consolidation loan over time. This simplifies the number of payments you have to make. The debt consolidation loan might have a lower interest rate than what you’re paying on your debts.

Before you take out a debt consolidation loan

• Keep in mind that a low interest rate could be a “teaser rate” that applies only for a limited time.
• After the teaser rate expires, your payments could go up because your lender can increase the interest rate.
• Although your monthly debt payment might be lower, it could be because you’re paying over a longer time.
• Taking the loan’s length of time, fees, and costs into account, overall you might pay more for the convenience of a consolidated loan than you would have had to pay for your original debt payments.

Credit repair

Credit repair companies make promises to fix your credit or improve your scores, typically by doing things you can do yourself for free. They often use advertising and social media promotions. They operate usually by noting negative items on your credit report and then sending disputes to consumer reporting companies, including the three nationwide credit reporting companies (Equifax, Experian, and TransUnion). The reporting company has an obligation to contact the creditor to verify the negative item. If the creditor does not respond within 30 days, the information is removed from your credit report.

There is a catch, however. If the reporting company decides that the dispute is “frivolous,” it does not have to investigate. This can happen if the reporting company gets multiple requests or requests that seem formulaic, which sometimes fits the profile of a credit repair company.

The only time you should dispute information is when it’s inaccurate. But credit repair companies typically dispute accurate items on your report, too. This could mean accurate items disappear temporarily while the credit reporting company verifies the information. After the item is verified, it reappears on your credit report. Your credit scores could change—and then change back—because of these actions.

Negative items that are accurate remain on your credit report for the appointed timeline. Negative information such as collections, charge-offs, judgments, and accounts reported late during the loan’s term remain on the credit report for seven years from the last activity or first delinquency date. Items are removed from the credit report once the seven years are up.

Before you start working with a credit repair company

• Keep in mind that there are no shortcuts to achieving a strong credit history or high credit scores.
• Consumer reporting companies, including the three nationwide credit reporting companies, remove negative items on your reports once they are found to be inaccurate or incomplete, or if they cannot be verified—whether the negative items are disputed by you or a credit repair company.
• You can dispute mistakes in your credit reports yourself, for free.
• Errors on your reports can be investigated and resolved, but credit repair companies cannot legally get information removed if it is accurate and timely.

Beware of monthly subscription fees. Many credit repair companies use telemarketing to sell their services. By law, a credit repair company that signed you up for services through telemarketing is not allowed to send you a bill or receive payment until two things happen:

1. The timeframe ends when they told you they would provide you their services. This means they cannot charge you an upfront fee or ongoing monthly service fee, so sometimes the company calls it a “subscription fee” instead.
2. They have sent you a report from a consumer reporting company. The report must show that they achieved the promised results, and it must be created six months after the results were achieved.