Behind the Credit Counseling Curtain

Credit card with dollars

People turn to nonprofit credit counseling for help paying back their debts and avoiding bankruptcy. Often, that's not how it works out.

Philip Walker of Jacksonville, Fla. paid his creditors more than $11,000 in 2008 through a repayment plan set up by ClearPoint Financial Solutions, one of the largest counseling agencies. Then one of his accounts went into collections and he was forced to file for bankruptcy anyway, according to his unsuccessful lawsuit against ClearPoint. About $35 a month of Walker's payments went to the credit counselor as a fee, court papers say.

"I think as a general point there are an awful lot of people who are still sucked into (repayment plans) that don't have a chance," said Henry Sommer, former president of the National Association of Consumer Bankruptcy Attorneys and currently the supervising attorney of the Consumer Bankruptcy Assistance Project in Philadelphia. Nonprofit credit counselors benefit from a reputation that they are your best bet for help in the problematic debt relief business. However, there are some things going on under their halo to be aware of:

  • Repayment plans fail roughly half the time, according to figures from the counseling industry; critics say the failure rate is probably higher. This is despite a screening process that accepts only about 20% to 30% of consumers into a plan. Paying into a plan that falls through, including fees of up to $50 a month for the agency, can exhaust resources and leave you financially weaker than before.
  • An agency might be posing as a nonprofit without you knowing it. Two of the largest organizations kept their nonprofit status for years while fighting Internal Revenue Service charges that they were really for-profit ventures in disguise. Consumer Education Services Inc. in North Carolina, known as CESI Debt Solutions, is still fighting an Internal Revenue Service revocation of its status that started back in 2004, according to a note in its 2010 annual report. Take Charge America in Phoenix, the sixth-largest agency, settled with the IRS in November of 2012, seven years after an IRS examination concluded that it abused nonprofit status to benefit the founder's family.
  • Consolidation is swallowing up smaller, local agencies while large players become nationwide, call center-based operations that advise thousands upon thousands of people. But consumers have little way to distinguish between them in the absence of published information about their success rates.

"Disclosure of outcomes is extremely important, because it's important people understand what they're getting into," said Andrew Pizor, staff attorney at the National Consumer Law Center.

The Payback BusinessBuoyed by referrals from lenders, nonprofit credit counseling agencies dispense advice to about 5.5 million people a year, according to the two main industry associations. The 10 biggest organizations make roughly $400 million in annual revenue and generate many times that amount in debt repayment. The largest agency, Money Management International, said it helped clients repay nearly $740 million in 2011.

If you are considering a repayment plan, the choice of a credit counselor is a big decision. Plans typically run three to five years, so fees can add up to $1,800 or more. If the plan falls through, you are unlikely to get another reduction in interest rates from credit card issuers, experts say.

What are the odds of success? Agencies rarely publish their graduation rates, so handicapping repayment plans is tricky. A poll of National Foundation for Credit Counseling (NFCC) members that was provided to university researchers found that only 21% of repayment plans were completed. Another 21% of participants pulled out in order to finish paying on their own, a form of success, while 51% simply dropped out or filed for bankruptcy. The figures were based on plans that terminated in 2002.

"Some folks go on a debt management plan with good intentions but fall out, or go to bankruptcy," said Gail Cunningham, vice president for membership and public relations of the NFCC. Agencies say that job loss or surprise expenses, such as medical difficulties, are frequently the culprit when plans fail.

But Michael Staten, an economist at the University of Arizona who studies credit counseling, found differences between the success rates of different counseling agencies. This held true even when other factors, such as the income of debtors, was held constant.

"Differences were pronounced for people who enrolled in (debt management plans)," he said. Staten found the difference between agencies while studying the success of telephone counseling, as measured by changes in consumers' creditworthiness. "We conclude it is something the agencies are doing."

Robby Birnbaum, president of the association that represents debt settlement companies -- the for-profit organizations that compete with credit counselors -- is skeptical about the reported success rate for credit counselors. He noted that only 21% of debt management plans actually went all the way to completion. It's a stretch to assume that other people who pulled out short of graduation actually made it to the goal line on their own, he said.

Debt settlement companies must follow certain regulations that credit counselors aren't subject to. "Our members can only charge a fee when they obtain a result for the customer," said Birnbaum, who heads the American Fair Credit Council. Legitimate debt settlement firms, which negotiate with creditors to make deep cuts in the principal balance of a debt, have been forbidden to charge upfront fees since 2010, he said, and are subject to oversight by the Federal Trade Commission. Clients make payments toward an eventual debt settlement, but these are kept in escrow and must be returned if the settlement doesn't come through, or isn't agreed to by the customer. Meanwhile nonprofit credit counselors are not regulated by the FTC and can charge monthly fees throughout the debt management program, despite the low odds of success.

Dropout factors Why not make graduation rates for agencies public? David Jones, president of the Association of Independent Consumer Credit Counseling Agencies (AICCCA), said most organizations resist publishing dropout rates because it would set up an unhealthy rivalry between organizations, putting them under pressure to boost their numbers. "These (rates) can be measured different ways," he said, "creating a competition that is not good for the consumer."

At least one head of a counseling agency disagrees. Cambridge Credit Counseling in Massachusetts, one of the 20 largest organizations, has made a practice of reporting its graduation rate as part of a transparency project.

"I've gotten some pretty heavy criticism from other leaders," Cambridge President Christopher Viale said. "At the end of the day, my data is my data -- if it is a little higher or lower than others, that doesn't bother me."

In its first-half report for 2012, Cambridge said that 54.3% of clients who enrolled during the first half of 2007 either completed their debt management plan, or left at a point near enough to completion to assume they finished on their own. The transparency project is part of an overhaul of the agency's practices since 2006, after its previous management came under fire for extracting high upfront fees from debtors.

When repayment plans fail, debtors themselves usually bear at least some of the responsibility. At ClearPoint, where Philip Walker went for help, repayment plans may fall through if one creditor balks at eased repayment terms or if the debtor simply misses a payment, spokesman Thomas Nitzsche said. He wouldn't comment about Walker's situation specifically.

Since the plans are a source of income for credit counseling organizations, the incentive exists to enroll people regardless of their chance of success. In addition to collecting monthly fees from the debtors themselves, the agencies receive "fair share" payments from lenders that are based on repayments made by debtors.

David Vendler, a Los Angeles attorney who has aimed legal challenges at the counseling industry, says the arrangement is rife with conflicts. Vendler represented Lori King of Georgia, who signed up for a debt repayment plan with InCharge Debt Solutions, the seventh largest agency in the U.S. She was told the plan would take 2.5 years to complete, but after 3.5 years, King was still making monthly payments, including $49 a month to InCharge, according to her lawsuit in federal court. Banks "manage to get the consumer to pay for the banks' cost of collection, which is awesome," Vendler said.

Justice Delayed Nonprofit credit counselors are organized under tax rules similar to charities, with a mission to provide financial education to the public. In 2003, the IRS announced it had launched an investigation of credit counseling out of concerns that agencies were neglecting their mission, abusing their exemption from consumer protection laws. The next year,  a congressional investigation lambasted nonprofit counseling agencies for charging high upfront fees that worsened people's debt woes. In 2006, the IRS issued a report saying it had yanked nonprofit status from nine agencies and proposed booting 30 others.

"The IRS did a deep dive into credit counseling, which we welcomed -- it was kind of the Wild West back then," said the NFCC's Cunningham.

It turns out that the West is not tame yet, nearly 10 years after the review was announced. Some of the agencies appealed the revocation of their nonprofit status for years, including two of the largest, while IRS privacy rules kept the disputes under wraps.

Details of CESI's ongoing dispute are still not public, and officers of the North Carolina-based agency did not respond to requests for interviews. With revenue of $34.7 million in fiscal 2010, CESI paid $15 million to Amerix Corp. in Columbia, Md., for debt management processing, plus $4.5 million to 3CI, also of Columbia, Md., for marketing, according to its annual disclosure form. Amerix was cited by congressional investigators in 2004 as being in the center of a for-profit debt relief operation that it controlled via service contracts with nonprofits, including CESI.

Family affair At Take Charge America, an IRS investigation concluded in 2005 that the Arizona agency had paid fees to real estate and software companies owned by founder Michael Hall, in addition to lucrative salaries for him, his wife, his son, two brothers-in-law, and at one point his 95-year-old father. Take Charge America was also cited for paying fees to a credit card company that referred debtors for enrollment in repayment plans. Finally, the IRS found that Take Charge's software referred to counselors as "salespeople," an indication that the agency focused on enrolling people in debt management plans.

The thousands of people who came to Take Charge for help did not hear about the questionable practices or its shaky nonprofit status, either from regulators or industry self-regulatory groups. The concerns became public only after Take Charge filed a U.S. Tax Court lawsuit against the IRS in late 2011, challenging the long-delayed plan to revoke its nonprofit status. The IRS wouldn't comment, citing restrictions on discussing a taxpayer's issues.

Take Charge America paid an undisclosed penalty to settle the IRS dispute in late 2012 and get back its nonprofit status. There were no requirements on the agency other than paying the penalty, said Michael Sullivan, Take Charge America's chief education and operating officer. "There were no orders to do anything differently," Sullivan said.

However, the organization was already doing things differently than it had when the IRS completed its examination in 2005. Founder Michael Hall and almost all of his family members had left their jobs by the time of the settlement in late 2012, Sullivan said. Take Charge paid a one-time fee to acquire rights to Hall's software, ending six-figure annual license payments to his company. Payments to the credit card company MBNA that referred debtors for counseling -- a practice that was cited by the IRS -- had ended before the IRS exam wrapped up. Also corrected during the exam was the reference to "salespeople" in company software, which was a programmer's mistake, the company said in court documents.

For a counseling organization, nonprofit status carries benefits over and above the exemption from having to pay taxes. Nonprofits are also exempt from the Credit Repair Organizations Act, which puts for-profit companies under restrictions enforced by the FTC. And certified nonprofits also have a big advantage in getting referrals and interest rate reductions from credit card companies. Finally, they are eligible for grants and donations from creditors and community organizations.

Sullivan said that the organization's ties to the Hall family may have created the appearance that self-interest was put above the public mission, but he argued that the appearance was not the reality. "Maybe there were more members of one family here than was appropriate, but we would take issue that we ever did anything harmful to a client," he said.

Jones of the independent counseling agencies group defended the group's decision not to revoke Take Charge's membership during its appeals, although nonprofit status is a requirement for membership. Whatever the questions about Take Charge's leadership, the AICCCA did not have evidence that Take Charge's clients were being harmed.

"Putting clients first is measured by the satisfaction of the client," he said. "They're not getting gouged by exorbitant fees, their bills are getting paid, they're not having their money stolen."

Others called for a higher standard of performance. In addition to being protected from outright theft, people who entrust their financial future to a counseling agency should be able to find out about the sort of management practices that the IRS found at Take Charge.

"It's pretty depressing that they could do that for so long," Sommer of the bankruptcy attorneys group said. "If you have a public mission ... there ought to be a little more scrutiny."