Study finds correlation between credit counseling and decrease in defaults

Those that were a bit wary of credit counseling can now enter into the process with greater confidence.

A new report – jointly published by the Federal Reserve Bank of Chicago, the Ohio State University and the office of the Indiana Comptroller of the Currency – found a direct correlation between credit counseling and a decrease in mortgage defaults.

The study looked at 211 borrowers who worked with the Indianapolis Neighborhood Housing Partnership, a nonprofit company that assists borrowers with low incomes and questionable credit histories, from 2005 to 2007. The INHP taught these borrowers the basics of household budgeting, savings, repairing their credit and buying homes.

The study compared the default rate for the INHP-counseled borrowers to 16,677 other low-income borrowers who got mortgage loans in the same county. INHP’s clients had an average annual income that was half that of the others studied, and an average credit score of 614. The INHP group also borrowed considerably less than the other subjects, an average of $69,900 compared to $108,000. Every one of those that received credit counseling also took a 30-year fixed-rate mortgage, compared to only 81 percent of the other group.

Despite all those obstacles, the study found that only 3.8 percent of INHP-counseled borrowers defaulted on their loans, while the larger population defaulted at a rate of 6.3 percent.

The study therefore concluded that the effects of credit counseling are strongest among those households that appear the least creditworthy judging by income and credit score. Further, the report also found that fraud is far less likely among those that go through credit counselors because of how long the borrowers have spent learning about the process, and as a result, may be more disciplined and frugal with their money.

According to a report in the Indianapolis Business Journal, the fed will use the study to help it consider policy decisions regarding whether it will encourage credit counseling across the country, or to crack down on lenders who try to exploit low-income borrowers.

"People who get in trouble are terrified of conflicts with their lender, so they don’t get in touch until it’s too late," Gene Amromin, a senior financial economist with the Fed, told the paper. "INHP knows exactly what happens to each low-income individual. They’re doing what any good portfolio lender should do."