Debt Counseling Helps Bankrupt Americans

There’s no doubt that American are doing a much better job cutting their debt. The average total household debt in the U.S. fell from $35,245 in 2008 to $16,046 in 2009, according to the Federal Reserve, while total U.S. consumer debt fell from $2.56 trillion in 2009 to $2.45 trillion by the end of 2009.

But that hasn’t stopped the bankruptcy train from chugging along on all cylinders. The American Bankruptcy Institute reports that there were 1.4 million consumer bankruptcies filed in 2009, and that there is a 17.5% rise in the number of U.S. consumer bankruptcies in the first quarter of 2010 compared to the same quarter in 2009.

Congress had acted to help consumers deal with bankruptcy, and the jury remains out on how effective 2005’s Bankruptcy Abuse Prevention and Consumer Protection Act turns out to be.

But one area where the law seems to be panning out is in its provision that financially-struggling Americans must undergo debt counseling before they file for bankruptcy. According to the law, before Americans can enter into the bankruptcy process, they must attend a 60- to 90-minute counseling session, where they are taught basic personal finance concepts; learn how to assess their income, expenses, assets and liabilities; and learn how to increase their income or cut expenses to improve their financial situation.

That portion of the law seems to be working — at least that’s the conclusion of a new University of Illinois study that measured the impact of the 2005 legislation’s debt counseling mandate on consumers. The study was co-sponsored by Money Management International (full disclosure: MMI bills itself as the “nation’s largest non-profit, full-service consumer credit-counseling agency”), and supervised by Angela Lyons, an economics professor at the University of Illinois.

About 32,000 MMI debt counseling clients were surveyed, according to a statement released by the nonprofit.

The study is a two-pronged effort to track debtors through the entire bankruptcy experience and then measure outcomes three to six months after they file for bankruptcy. The goal was to measure the effects of the 2005 consumer bankruptcy bill and see if debt counseling had a positive or negative effect.

Working against the study was a fairly substantial “gray area” between some bankruptee’s. Lyons points out that the educational requirements of the bankruptcy legislation have drawn some criticism from consumer-rights advocates. “There is concern regarding whether or not the legislation is creating an administrative obstacle for people who are in dire financial straits, many of whom may be in trouble due to circumstances not in their control,” Lyons said. Specifically, she explains, people who have lost their jobs or suffered a serious illness don’t really need a government-mandated primer on credit card debt.

Says the study: “Opponents of the educational requirements argue that some debtors may be in serious financial debt due to having large medical bills or due to unemployment, as examples. These individuals may know how to manage their finances, but through no fault of their own are now in serious debt.”

But what about individuals who do bear the brunt of their bankruptcy situation? Does debt counseling seem to help them? “We found that, overall, debtors did see improvement in their financial knowledge, attitudes and behavioral intentions,” Lyons said. “More than 99% of the participants indicated the counseling course was helpful.”

“We also found that, typically, there are multiple factors that lead individuals to file for bankruptcy,” she added. “Even for those individuals who were in debt due to medical bills or unemployment, there were other money management factors at play. However, no matter what the reasons were for individuals getting into significant financial debt, they still benefited from taking the counseling course.”

“Preliminary evidence points to marked improvements in financial management skills and practices, which suggest that credit counseling and education may in fact be a viable mechanism to help debtors deal with their financial situation and obtain a fresh start,” Lyons concluded.

Click here for a closer look at the study.

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