Credit Counseling - How Does It Work?
Debt Management Programs
Looking back over their financial life together, Bill and Rita readily admit to how difficult it has been. Constant worries about bills and payments have made life unbearable at times.
For years this couple has lived beyond their means, ignoring all the financial danger signals and fooling themselves into thinking things will get better by themselves. Now due to life circumstances, their financial picture has taken a turn for the worse and debt collectors are calling daily demanding money that they are not able to pay - their debt situation is clearly out of control.
Rita and Bill are in my credit counselling office prepared to do whatever it takes to regain control over their financial lives and stop the collection calls.
In order for us to get a clear picture of their financial situation, we list their assets, then their household income from all sources. Next we list their expenses - regular (expenses paid every month) and irregular (expenses paid annually or irregularly), they are surprised at the result. You can do too by downloading our budget sheet.
Rita and Bill discover that their monthly living costs currently exceed their income before they make any consumer debt payments. They have been using credit to balance the budget each month. Using credit to pay credit, therefore growing their debt by paying it. The chart below shows that they are short nearly $1,250 per month.
|Monthly Cash Flow|
|Total family net income (take-home)||$2750|
|Total monthly expenses||$4000|
Bill and Rita are also very surprised to learn how much their total debt load is; they know their loan balance at the bank is low, but since they have never sat down and added up the rest of what they owe, they hadn’t realized just how much money they owed in total and how quickly their credit card debt had climbed to a total of $30,000.
When I go over the monthly statements from the various creditors, Rita and Bill get another surprise: the balances are increasing, despite their sporadic payments and recent purchasing restraints.
Some of their cards are over limit and some of the companies have a surcharge fee for both over limit and for late or missed payments, in addition to high interest rates. These extra fees are as high as $25 per statement for some creditors. One of the credit cards has raised their interest rate from 18% to 23% because they are behind in their monthly payments. The seriousness of the situation is becoming clear now.
Rita is in tears, “How are we ever going to stop this?” she cries.
Credit counselling usually begins with an assessment followed by a review and advice regarding possible solutions.
Step 2 - Financial analysis
The financial analysis includes a complete listing of income, living expenses, and debts.
Once we have gone over the income and expenses to determine what Rita and Bill can afford on a monthly basis, it becomes apparent they will be required to reduce their living expenses, or increase their income, or do both. They think the potential for increasing their income is very good since Bill has a lead for a second job, and they know they can cut back on their living expenses.
To start this process we decide on cutting back the obvious - reduce their gift giving and eating out. Take lunch from home each day, no more daily Starbucks and no vacation until their financial situation improves. They propose to cut expenses further by dropping the extras from cable TV and entertainment.
Before encouraging them to make any more sacrifices, I suggest they take some time to consider the implications of these changes and to decide what other actions they might take to reduce expenses as we start this new program.
Step 3 – Credit solutions
One of the solutions for Rita and Bill is a Debt Management Program (DMP). A DMP is a consolidation of payments.
It is not a loan and it is not for everyone.
A Debt Management Program is a voluntary repayment program set up by a Credit Counselling/Debt Pooling Agency (licensed by the Government and operating under a Bond and through a trust account). DMPs are designed to have the client debt free in four to five years maximum (studies have shown programs designed for longer terms are less likely to succeed). All monies are deposited into a trust account for the benefit of the creditors and are paid out, usually once a month.
- We create proposals to the creditors in writing - we ask the creditors to reduce or stop the interest charges on their accounts in order for our clients to pay their debts faster – most creditors will agree. However, if the debtor does not complete the DMP the creditors can recalculate the total interest to the loan.
- We supply the creditors with a complete SOA – statement of affairs, a copy of the family budget and income statement to assist them with making a decision regarding their outstanding debts.
- We do not give out personal information without our clients prior written consent.
DMPs are designed to work with unsecured debts and most creditors are very co-operative, as they want to get paid and to help their customers get back on their financial feet.
Once the creditor agrees in writing to the terms offered in the DMP – the payments will commence until the debt is repaid – the credit counselling client is advised to get a statement from the agency at least once a year detailing the payments in and out. Some creditors will send statements during the DMP others will not.
DMPs are a win-win situation for both the debtor and the creditor – however some creditors remain difficult to deal with and we recommend that you seek assistance from a licensed and qualified credit counsellor.
Some side effects of a DMP
Debt Management Programs will affect your credit rating for 3 years from the completion of the proposal. Your creditors, not your credit counsellor - are the ones that report your rating to the credit bureaus and they may report your credit file as an R7 if you are on a credit counselling program. R7 means that you are participating in and paying as agreed by a Debt Management Program.
You will agree not to apply for more credit while on the DMP without consulting with your credit counsellor first. Your counsellor should contact you at least once a year to update your file and see if your financial circumstances have changed – perhaps the program can be paid off sooner.
Credit counselling usually pays the debts off in full – it is meant to provide a viable alternative to those people that are experiencing financial difficulty and wish to avoid filing for bankruptcy.
In order for credit counselling to work you must qualify for the program – there is no point in setting up a program that you can not afford to pay - only to end up in a bankruptcy trustees office down the road.
Go over your budget with your counsellor carefully - are you going to be able to live on it? If not, then perhaps credit counselling and a Debt Management Program are not for you.
Thousands of Canadians have avoided bankruptcy and are repaying their debts through credit counselling – it works and you can prove it.