Is the Cure Worse Than the Disease?

I've heard that using a credit counselor can have a devastating effect on your credit report. Is it true?

The answer is yes — and no. Would this show up on a credit report? Probably. Would it be as damaging as declaring bankruptcy? Absolutely not. But that doesn't mean there are no side effects. Here's what to consider before enrolling.

First of all, if you do seek credit counseling, you certainly aren't alone: Millions of Americans visit credit counselors each year. Some simply attend educational seminars or have a professional give them a one-time evaluation. Others take it a step further by enrolling in a debt-management plan, or DMP, with the counseling agency. With these types of plans, the agency works with creditors to set lower rates and reduce the minimum monthly payments. Clients then send a single monthly check to the agency, which in turn pays each lender.

Does all of this appear on one's credit report? For those who do not enroll in a DMP, the answer is no. Those who do will probably get a note on their report that says "enrolled with a consumer counseling service," or "payment received through XYZ credit counseling agency," says Lydia Sermons-Ward, senior vice president for marketing and communications at the National Foundation for Credit Counseling.

This will impact one's credit report in that the information will be available to potential lenders to see and consider when making a lending decision. But just how a specific lender will view this varies. "Some creditors will look at it as a positive sign — the consumer is looking to correct the situation," Sermons-Ward says. "Other creditors will look at it as a negative reflection of how a consumer managed debt in the past, and they may choose not to extend credit."

Either way, the note on a credit report is in no way associated with bankruptcy, be it for Chapter 13 or Chapter 7. "It's simply a code or remark that we put in the report...(that) is considered neutral," says Jeffrey Junkas, a spokesman for TransUnion, one of the three major credit bureaus.

Perhaps more important, enrolling in a DMP will have no effect on a consumer's credit score (also known as a FICO score), which is often his or her first point of contact with potential lenders. "When FICO sees that information, it ignores it," says Craig Watts, a spokesman for Fair Isaac, the company that calculates FICO scores.

But even though FICO is blind to the fact that you're involved in credit counseling, keep in mind that it continues to track how you handle your debt obligations, Watts notes. So if a consumer changes his or her behavior while in counseling, even if that doesn't involve participation in a DMP (say a counselor tells them to close all credit accounts except one or to consolidate all debt on a single credit card), "those actions would have an effect on your FICO score, and a great one," Watts says. (Click here to see how different actions alter your credit score.)

Of course, in the long run enrolling in a DMP should have a positive impact on one's credit. "When people get to the point of seeking consolidation, they are late on paying bills already," says Gerri Detweiler, author of "The Ultimate Credit Handbook." So simply replacing a poor payment history with a good one is a step in the right direction. In some cases, counseling agencies can also convince lenders to "re-age" an account, which means the account will be brought up to date and late payments will be removed from the credit report.

That said, don't take for granted that once you enter a DMP the counseling agency will take care of everything, says Detweiler. "You need to stay on top of it and make sure the payments are being made properly." If the agency isn't making payments or is late on payments, Detweiler says, your credit will suffer. "To the creditor, you're not released from the contract — you're still considered responsible for it," she says.

So be careful when selecting a counseling agency. Ask in advance what fees it charges (typically, fees range from $3 to $10 a month per creditor). And be sure to check with your local Better Business Bureau or state Attorney General's office for previous complaints.

The National Foundation for Credit Counseling and the Association of Independent Consumer Credit Counseling Agencies are two of the most reputable nonprofit organizations.