Credit counseling, despite its name, is more a type of debt management counseling. Rather than helping people use their credit, it helps people manage their current debts and, frequently, avoid filing for bankruptcy. While it is frequently seen as a type of credit education, it is really debt counseling.
The procedure of credit counseling involves a debtor creating a debt management plan (DMP). The DMP will be drawn up by a credit counselor who works with a consumer/debtor's creditors to negotiate a repayment plan. Frequently, these plans will involve a lower interest rate or longer time frame than the debtor would have if he or she worked from the original loan or statement. In addition to reducing the interest rates, a DMP will often offer reduced payments and fees.
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After a debtor joins a debt management plan, the creditors will close the accounts or restrict future charges. This prohibits the debtor from incurring more debt which would also have to be paid off. A DMP's best feature is that it consolidates all of a consumer's debts into one monthly payment. While the payment might seem high, it is usually less than the amount the consumer would pay if he or she paid all bills individually.
Another feature is the reduction of interest rates. The bank or other creditor feels that he or she has a much better chance of getting money back and so will view a consumer as less of a risk. This allows them to lower the interest rate they charge the consumer. Lowering an interest rate, which on credit cards can be near 30%, allows the consumer to be debt free in 3 to 6 years rather than the 20+ years it could take with normal interest rates.
When a consumer creates a DMP, he or she benefits by having formerly delinquent accounts marked as current. Banks will frequently do this after a consumer makes three monthly payments. It is a show of good faith in the consumer to repay the debt. In addition, this helps a consumer's credit rating. Bills that were listed as "late" or "delinquent" will still appear on a credit report but they will be balanced by "on time" payments.
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