Bankruptcy lite: Dark side of credit counseling

To thousands of over-extended consumers every year, it looks like a face-saving alternative to the unpleasant consequences of personal bankruptcy.

But the relentless come-ons from credit counselors to debt-ridden Americans rarely mention the exorbitant fees that are often involved, or the industry's dirty little secret: third-party debt management can be hazardous to your credit score.

Attorney General Tom Reilly's office routinely receives dozens - and sometimes hundreds - of complaints a year about shady credit counselors known for lining their pockets at the expense of desperate customers.

But next week, a new federal law will require those who are seeking personal bankruptcy to first attend credit counseling sessions - forcing financially vulnerable people into the clutches of an industry with a questionable record.

It is so riddled with unscrupulous operators that the Internal Revenue Service said earlier this week it may yank the tax-exempt status of about 20 credit-counseling firms nationwide - accounting for half the industry's revenue - due to hundreds of complaints about deceptive business practices.

"Congress couldn't have picked a worse time to mandatate use of credit counselors,'' said Travis Plunkett, legislative director of the Consumer Federation of America. ``There are a number of predatory (counselors) out there.''

Plunkett and other watchdog groups praised the Justice Department's U.S. Trustees for coming up with a list of what it considers legitimate nonprofit credit counselors who must be used by those seeking personal bankruptcy.

The new law, backed by the loan industry and OK'd by Congress in March, requires that any debtor who files for bankruptcy after Oct. 17, 2005, must undergo credit counseling within six months before they file for bankruptcy.

But Chris Barry-Smith, an assitant attorney general in Reilly's office, said his office plans to be "diligent'' in monitoring what happens due to the industry's dubious record.

"A number of states - including Massachusetts - are going to keep a close eye on matters,'' he said.