Credit counseling: Help or hindrance?

Star Tribune (Minneapolis) (MCT) - 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.

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 underwater, 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.

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"Many families are finding they can work their way out of debt without filing for bankruptcy, without walking out on their solemn obligations," Sen. Jeff Sessions, R-Ala., said during debate on the bankruptcy bill.

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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.

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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 that 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.

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Of the roughly 5,000 families that Stillwater, Minn.-based financial counseling agency Family Means has seen since the law went into effect, operations director Jim Kroening can count on one hand the number of families who avoided bankruptcy.

Yet he's quick to say that the requirement isn't a wholesale failure. "I think we are educating them, not only on their options, but probably more importantly on what to do differently to avoid this type of situation in the future," he said. That is also the point of the post-bankruptcy financial education that's required to put the bankruptcy experience behind a debtor.

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"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.

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More than 150 agencies have been approved by the U.S. Trustee Program to conduct the counseling. The average cost: $50. Some were created just to perform online bankruptcy counseling, while others have been in the financial counseling business for decades. One counseling firm advertises being open 24 hours a day.

"Receive your certificate within an hour of completion," the Yourbankruptcypartner.com site boasts.

And though in-person counseling is considered the best, just 11 percent is done that way. Nearly half _ 46 percent _ of counseling is done online, according to the latest data available from the U.S. Trustee Program.

A study group of government agency officials and bankruptcy experts as part of the Rand report "felt that Internet counseling alone is insufficient."

"There are a ton of attorneys that just want it done the quickest, easiest, cheapest way possible" and they are sending clients to "canned stuff on a screen," Bialobrzeski said. But even he is feeling pressure to offer Internet counseling in addition to phone services, because he's been losing a couple of percentage points' worth of market share each year. Despite his volume business, in-person and phone-based sessions cost more than they make back in fees. With start-up costs factored in, he said Green Path won't break even on pre-bankruptcy counseling until at least 2011.

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"This is not the financial windfall that some people think," he said.

Holed up in the storage room, Sherman failed to see the point of the counseling. She had to list her income, expenses and debts copied from her bankruptcy petition.

The computer asked, "Are you behind on your credit card debt?" "Do you have any money in savings?" "Have you bounced any checks?" "Are you worried about your financial future?"

She dutifully answers, occasionally with a snide remark.

"Are you only making the minimums on your credit card payments?" the program asks. She stopped making payments, she answers _ one of the reasons why she's seeking bankruptcy protection.

"I panicked, closed my eyes and ran" from piles of credit card bills, she explains during the counseling. Sherman readily admits that her downfall was accepting the preapproved credit card offers she received in the mail. With her paycheck from her production job barely covering expenses _ without factoring in debt payments _ the 44-year-old who lives in a northern Twin Cities suburb didn't need counseling to tell her she couldn't pay back her debts.

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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 went with one Internet-based counseling firm that he knew some other attorneys use and includes the $49 fee as part of his payment. He says that 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."

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© 2008, Star Tribune (Minneapolis)