The Success and Failure of Counseling Agency Debt Repayment Plans

Eastern Economic Journal, 2012, 38, (99–117) r 2012 EEA 0094-5056/12 www.palgrave-journals.com/eej/ 



Daniel T. Brown, Charles R. Link and Michael E. Staten


ABSTRACT
This paper investigates whether success on a counseling agency-administered Debt Management Plan (DMP), as measured by the amount of original debt repaid, can be predicted at the time of counseling based on observable client and debt attributes. The paper utilizes a unique database of over 17,000 consumers who were counseled and recommended for a DMP by a large non-profit credit counseling agency during 2003. Of particular interest to counseling agencies and creditors is the finding that the magnitude of the interest rate reduction offered by creditors to consumers on a DMP has a significant, positive influence on debt repayment.


Keywords: Debt Management Plan; consumer finance; bankruptcy; credit counseling JEL: D11; E21; G21


INTRODUCTION
Millions of American consumers seek advice and assistance from a credit counseling organization each year. Upwards of one-third of these consumers enroll in voluntary repayment plans, called Debt Management Plans (DMPs), as an alternative to bankruptcy. Counseling agencies broker these unique plans by getting creditors to voluntarily exercise mutual forbearance in the form of concessions on finance charges and repayment terms, a halt to late fees and collection calls, and a re-aging of accounts to “current” status while the consumer is on the repayment plan. But, the majority of DMPs terminate prior to completion. Creditors worry that some borrowers opportunistically enroll (with the tacit approval of counseling agencies that act as screeners) just to get a temporarily lower interest rate with no intention of sticking with a plan to its conclusion. The moral hazard risk has contributed to creditor reluctance to make deep concessions on plans. But, a DMP can be a far less costly debt relief option for many consumers than either bankruptcy or debt settlement.1 Creditor reluctance to make concessions leaves many consumers unable to qualify for a beneficial DMP, as will be explained below.
This paper investigates whether success on a DMP, as measured by the amount of original debt repaid, can be predicted at the time of counseling based on observable client and debt attributes. One objective of building such a model is to identify the impact of creditor concessions on DMP participation and completion. In addition, a predictive model accessible to both counselors and creditors could be used to move the industry away from the typical one-size-fits-all DMP and toward a system in which creditors are more willing to make deeper concessions for those consumers with a demonstrated greater need. A predictive model could also help to boost DMP completion rates by giving agencies a tool to make operational adjustments to allocate more resources to clients who are likely to need extra assistance as they work through their repayment plans.

We are not aware of any prior econometric studies of the determinants of DMP payment experience. With more than 1.5 million households projected to file for bankruptcy in 2010, at the same time that credit card chargeoffs for the largest issuers have soared about 10 percent of outstanding balances, there is clear need for creditors and counseling agencies to reduce the barriers to making DMP products available to a wider segment of consumers in order to prevent bankruptcies and lower losses.2 This paper examines the factors that determine the repayment of debt through a DMP using data on over 17,000 consumers who were counseled and recommended for a DMP by a large non-profit credit counseling agency during 2003. The objective is to identify attributes observable at the time of counseling that predict which consumers will be more likely to do well on DMPs, among the pool of clients for whom a counselor recommended a DMP at the end of the initial counseling session.
The paper is organized as follows. We first provide background on the DMP and the resulting partnership between consumers, counselors, and creditors. Then a brief literature review regarding the potential determinants of DMP success is given. The methodology underlying the research is then discussed. Next, the data used in the empirical models are described. Regression model estimates of DMP repayment are subsequently analyzed. We then acknowledge and explore sample selection issues and provide additional insight into the effectiveness of the counseling agency’s screening process. Finally, we offer concluding thoughts. 


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