Credit Counseling

An important provision of the new bankruptcy law that some commentators have overlooked is the requirement that consumers filing for bankruptcy must first complete credit counseling. While the Senate and House bills differ in some respects, they agree on the requirements for credit counseling before a consumer files for bankruptcy. In her article in the Wall Street Journal, Dawn Kopecki explains,"Debtors will have to submit a certificate verifying that they have completed the credit education course along with their bankruptcy filing. Then before their debts can be completely discharged, they must complete a more intensive financial management training course."

Just how are all of these courses to be provided? An underlying challenge is the requirement that the organizations providing the counseling be nonprofit and offer the service "at a reasonable fee." Moreover, debtors who cannot pay such a fee must be given the service without charge. Organizations seeking to provide these services must be certified by the Justice Department, which is currently drafting guidelines that credit counseling agencies must meet to be certified to deliver the counseling required for the bankruptcy process.

Like personal bankruptcies, the credit counseling industry has mushroomed over the past two decades. The National Foundation for Credit Counseling (NFCC) is a non-profit umbrella organization that oversees 200 independent, non-profit agencies that offer counseling at 1,500 locations around the U.S. In 2000, NFCC-affiliated agencies provided counseling sessions to over 1.4 million consumers. Exact statistics regarding the size of the counseling industry are difficult to compile, but NFCC believes its members account for about 50% of credit counseling activity nationwide. Many non-NFCC organizations are for-profit businesses.

Over 75% of the revenues at NFCC agencies come from contributions from credit grantors. Most of this revenue is a "fair share" contribution calculated as a percentage of the payments to creditors from consumers for whom the agency brokers a debt management plan to facilitate resolution of debts over a pre-set time period (e.g., 48 months). Competition from new entrants to the counseling business has bid down fair-share rates more than 50% over the past three years. As recently as 1995, creditors were paying fair-share rates equal to 13% of debtors' payments. On average, that fair share rate has fallen to between 6% and 7%.

Many counseling agencies are wary of the new bankruptcy statute. Already in the process of struggling with new competitors, some agencies dread another wave of new entrants that may spring up to service more than 1.3 million consumers who currently file for bankruptcy each year. But, the problem for agencies is more complicated. While creditors are generally supportive of the counseling alternative, many have long worried that some agencies don't do enough to discourage their clients from heading to the bankruptcy court. Creditors also worry that some agencies are negotiating finance charge and payment concessions from creditors on behalf of clients who don't really need them. With their reputations among creditors already on the line, many counseling organizations are wary of being thrust into any official role in the bankruptcy process.

But, there is still another angle to the story. A fundamental premise of the counseling requirement in the new law is that many debtors head to bankruptcy court to solve their financial problem without full information regarding their non-bankruptcy options. Credit counseling that would help debtors restructure their budgets, and debt management plans in particular, may be viable alternatives for thousands of consumers who are currently filing Chapter 7. Research presented to Congress over the past three years suggests as many as 15 -20% of current Chapter 7 petitioners (140,000 households) could repay enough of their unsecured debts to qualify for a five-year debt management plan. Some agencies are betting (and Congress is hoping) that mandatory counseling prior to filing the bankruptcy petition may dissuade some consumers from the bankruptcy option. If the consumer sets up a debt management plan instead, the counseling agency has a new stream of revenue.

The dilemma for the agencies, then, is to create a counseling product designed specifically for the consumer who has already decided to file for bankruptcy, that will be effective in turning some clients away from the bankruptcy court and toward a repayment plan (that generates agency revenue), but can be offered at sufficiently low cost to keep the agency in the black when many clients continue on to bankruptcy court.