Ask Liz Weston

Dear Liz: I am 75, in poor health and live only on Social Security (I get $1,046 per month). I’ve been told that if I want, I can stop making payments on two credit cards that I owe on and will never be able to pay off. Is that true? I can’t afford to file for bankruptcy.

A: Normally, when someone stops paying a debt, the creditor will start collection attempts and may file a lawsuit. If the suit is successful, the creditor gets a judgment and can take further actions, such as garnishing wages or taking property.

If your only source of income is government benefits, though, and you have no home or other assets that can be legally taken to satisfy your debts, then generally you’re considered ‘judgment proof.’ That means a creditor is unlikely to get any immediate payment if it sues you in court.

That doesn’t mean lawsuits won’t be filed, however. A creditor may get a judgment against you hoping to get something out of your estate when you die. Even if no suit is filed, you may have to deal with collection calls and letters that can continue for years, even decades.

If you really can’t pay these debts, then you might want to consult with an experienced bankruptcy attorney about your options. Many offer free initial consultations, and they may be able to help you find an affordable way to file your case if that seems like the best course.

Dear Liz: Our question is about student loans.

We have a total of $69,000 in education debt. We also have a home worth $400,000 and our mortgage balance is $266,000, plus a home equity loan with a balance of $14,500.

We make a good salary, have excellent credit, pay all our bills on time, and, if gas weren’t so darn high, we would have a decent amount of discretionary income.

We make extra principal payments when we can. The problem is that interest rates on our school loans are climbing, and payments are getting higher and higher.

We’re wondering whether we should take out another home equity loan to pay off the student loans.

That would obviously leave us with less equity, which could limit the price we could pay on the house we plan to buy in three to five years.

But it would also decrease our monthly loan payment significantly and we would be able to deduct the interest on the home equity loan. (We can’t deduct student loan interest because we make too much money.)

Does a home equity loan make sense in this case?

 

Answer: Generally speaking, trading student loan debt for home debt isn’t a great idea.

 

Student lenders typically are much more flexible than mortgage lenders, with a wider variety of repayment options. You also can get a deferment or forbearance if you lose your job or otherwise encounter a financial hardship. This respite from payments can last as long as three years on many student loans.

 

Compare that with what would happen if you couldn’t make your mortgage payments. Within a year, and usually much less, your home lender would start foreclosure proceedings.

 

In addition, most student loan debt can be consolidated. This would allow you to lock in your current interest rate and perhaps lengthen the repayment term to lower your monthly payments.

 

A longer loan means you would pay more interest over time, but it could help ease the monthly crunch you’re feeling.

 

All that said, not being able to deduct the interest on your student loans is a significant disadvantage.

 

If you’re confident you’ll be able to make the payments, then you might consider paying off at least some of your student loan debt with home equity borrowing.

 

You should, however, limit your total borrowing all your home equity loans plus your primary mortgage to no more than 80% of the value of your house.

 

You want to keep at least a 20% equity cushion in your home whenever possible, as a last-resort emergency fund and also to protect yourself in case of declining home values. (You don’t want to be faced with having to sell your home and owing more than it’s worth.)

 

Given the loans you already have, you should be able to pay off $39,500 of your student loans with home equity debt. Then you could consolidate the remaining $29,500.