Credit counseling: Help or hindrance?

MINNEAPOLIS -- Elizabeth Sherman slouches in front of a computer tucked in the storage room of her bankruptcy attorney's office.

"Have you already decided to file for bankruptcy?" the computer questionnaire prompts her.

"Well, yeah. I'm already taking the test," she says to the screen.

The "test" is the credit counseling she must complete in order to file for bankruptcy, one of many changes enacted as part of the 2005 bankruptcy reform law.

But the seemingly innocuous requirement -- few are against financial literacy -- has become controversial, with critics charging that it is just an added layer of expense to bankruptcy, which has already become a much pricier option under the new law.

Meanwhile, the "counseling" is most often little more than Sherman's experience -- a series of yes or no questions from a computer that doesn't provide meaningful options. And there's no data to show how many people counseled still file for bankruptcy.

"It's just an extra hoop to jump through," said Tim Theisen, Sherman's attorney. Other lawyers call it demeaning to filers who are facing catastrophe.

Unclear goal

Studies from the Government Accountability Office and the Rand Corp. found that the goal of credit counseling is unclear and that there is little analysis of whether the counseling is working. "The requirement may often serve more as an administrative obstacle than as a timely presentation of meaningful options," according to the GAO report.

Even some in the financial services industry admit it's too little, too late. "We need to reach consumers much sooner in the financial cycle," said trade group Financial Services Roundtable CEO Steve Bartlett in late 2006 before a Senate subcommittee that was evaluating the implementation of the bankruptcy reform. "If consumers wait until they are completely under water, counseling may not live up to its full potential."

The credit counseling requirement was designed so that consumers "will make an informed choice about bankruptcy, its alternatives and consequences," according to the report of the Committee on the Judiciary for the House of Representatives that accompanied the proposed reforms.

Supporters suggested that it might cut the number of bankruptcy filings by 10 percent, as people worked out payment plans to get themselves out of debt.

But counselors and bankruptcy attorneys interviewed for the GAO study estimated that fewer than 2 percent of pre-filing credit counseling clients enter debt management plans instead of bankruptcy. According to the most current data available, a National Foundation for Credit Counseling member survey found that 3 percent of clients between October 2005 and August 2006 signed up for a debt management program.

The U.S. Trustee Program for the Department of Justice, which oversees the bankruptcy process, said that, in the first nine months of the new law, 14 percent more credit counseling certificates were issued than bankruptcies filed. But spokeswoman Jane Limprecht said newer data are not available, and she declined to comment about whether this means that credit counseling is helping families find workable alternatives or if there's another explanation, such as families failing to file because they can't afford to.

"It's going to take a few years to figure out how many of these people will truly avoid problems in the future," added Rick Bialobrzeski, director of business development at GreenPath Debt Solutions, a national phone and in-person counseling service based in Farmington Hills, Mich., that issues roughly 16,000 pre-bankruptcy counseling certificates per month.

Too late

By the time Sherman sat down for her counseling, none of the cookie-cutter bankruptcy alternatives listed by the online counseling program made sense.

Transferring credit card debt to another card with a 0 percent interest rate offer, for instance, is nearly impossible for someone with delinquent payments. The advice to refinance her house to pay off her credit card debt was an overused strategy from the real estate boom that has homeowners who owe more than their houses are worth wondering why they ever thought that was wise.

Even if the suggestions were relevant, she'd already paid Theisen hundreds of dollars in fees to handle her case.

For Theisen, who said 80 percent of his cases are bankruptcies, the counseling requirement has been an added burden, part of a series of increased paperwork under the new law.

Clients slow to pay the counseling company would delay their bankruptcy filings into the next month, causing Theisen to recalculate income and redo tests required by the new law.

So, he bought a computer for clients to complete the required counseling session in his Anoka, Minn., office. He said he thinks the current counseling system is backward.

"Going through debtor education should be a prerequisite to obtaining credit," Theisen said. If they're already consulting with a bankruptcy attorney, "It's too late by then."