Ask Liz Weston

Dear Liz: I’m in a potentially bad situation with my home equity line of credit. I’m trying to refinance my primary mortgage and would save nearly $150 a month. But the HELOC lender is dragging its feet on agreeing to a subordination. If the lender doesn’t agree, I lose the deal. I’m wondering why the lender does not believe it to be in its interest to help when I am trying to improve my financial situation. Can you give me some insight into the line of thinking here?

Answer: Unfortunately, many would-be refinancers are in your uncomfortable position. They have a second mortgage, such as a home equity line of credit, on their property. These loans are known as “seconds” because the lender is in second position to be paid off when the home is sold, after the primary lender has been paid.

For a refinance to proceed, these HELOC lenders have to agree once again to be subordinated into second position. Some lenders balk because they don’t believe their borrowers have sufficient equity to cover both loans (even though, as you note, a lower payment on the first mortgage could make it more likely that the borrower could make payments on the second).

But a bigger problem seems to be lack of staff and lack of priority. Lenders are so busy trying to meet the demand for refinancing that other concerns, including subordination, often fall to the bottom of their to-do list.

That means you have to be extremely vigilant if you don’t want your refinance deal to fall apart. Call your new lender and your HELOC lender every few days to track the progress of your subordination. If there are problems or missing paperwork, promptly address those issues.

If your rate lock is within two to three weeks of expiring and your subordination still hasn’t been approved, call your HELOC lender and politely ask that your request be given top priority.

If you can’t get through to the subordination department’s main line, ask the phone reps if there is a fax number or e-mail address you can use. If all else fails, take your problem to the bank’s chief executive. You’ll find the name and address online.

Dear Liz: I’m curious about your recent answer to the folks asking about a short sale. In it, you said, “Short sales . . . typically harm credit scores as much as foreclosures do.” As a real estate professional, I am under a different impression.

Certainly, in financial distress, one’s credit score takes a beating, but I don’t believe there is a code or classification for short sales on credit reports. We generally encourage short sales when possible as we feel short sales allow a debtor to get back on their feet quicker. I’d appreciate other data if you have it, as this would change how I educate clients. I do think we may see some changes in the future. As the number of short sales increases, we may see some way to note such transactions on credit reports.

Answer: The information about how credit scores are affected by short sales comes directly from FICO, the company formerly known as Fair Isaac Corp., which created the leading credit scoring formula.

You’re right that the formula has no specific code for a short sale, which is when the lender agrees to accept the proceeds of a home sale as full payment of a mortgage, forgiving whatever additional balance is owed. But most lenders report short sales as a debt settlement, which has a strongly negative effect on credit scores.

In many cases, the borrowers’ scores were already trashed by late payments and by the notice of default, which is filed by a lender after several skipped payments. A settlement notation or a foreclosure just makes a bad situation worse.

But you may have a good point about the debtor potentially being able to bounce back faster with a short sale. The foreclosure process can drag on for months, and sometimes more than a year, with each missed payment causing additional damage to the borrower’s score. Arranging a short sale may help a borrower put an end to the credit damage so he or she can start the long road back to better scores.

Guardian angel

There may or may not be a custody battle brewing over Michael Jackson’s kids. (His mother was granted temporary custody of the three, ages 7 to 12, and is seeking to make that permanent.)

But there may be a battle over YOUR kids if you die without a will or other estate document that names a guardian. Even worse: your kids could wind up in foster care.

Sometimes parents put off this necessary chore because the partners can’t agree on a guardian, or simply because they don’t want to deal with the possibility of their own deaths. Get over it. Your children are the ones who will suffer if you don’t get your act together.

Quicken WillMaker costs $40 and will give you the legal documents you need. If your estate is complicated or you have contentious relatives, you may want to invest in the services of an experienced attorney.

But do it now. Don’t leave it to fate, or the courts.

For more, read:

• Who will take your kids if you die?
• 3 legal documents you shouldn’t live without
• 5 big myths about the estate tax

Target-date funds can be a good choice for people new to investing, or those who simply don’t want to mess with the details of picking asset allocations and rebalancing their portfolio. Many big-company 401(k) plans now offer target-date funds, as do most big mutual fund companies and brokerage firms.

These funds do all the heavy lifting for you, gradually adjusting the investment mix over time so you take less risk as you approach your “target date”–typically a year near when you plan to retire.

But apparently a lot of people have misconceptions about target-date funds and what they can accomplish.

Behavioral Research Associates interviewed 250 Americans and found that many thought the investment option offered some kind of guarantee. For example:

•    Over 60% of employees say that investing in target-date funds means they will be able to retire on the target date.
•    38% think target-date funds offer a guaranteed return.
•    30% of workers think they can save less money and still meet their retirement goals if they invest in a target-date fund.
•    Over 23% of workers believe that there is little to no chance that they will lose money either before or after the target date.
•    41% think there is little to no chance of losing money in any one-year period, and
•    70% think they are equally as likely or less likely to lose money in any one-year period, as compared to investing in money market funds.

Obviously, none of these misconceptions is true. Target funds adjust your risk over time, but they certainly don’t eliminate it. Even when you approach your retirement date, your target fund may still have half or more of its assets in stocks.

That doesn’t mean you should bail on your target-date fund, but–as with all investments–you should understand the real risks and rewards.

You can CLICK HERE to read the researchers’ comments to the SEC and Department of Labor about their findings.

For more on this topic, read:

• One-fund retirement: Buy and forget
• Don’t shy away from target-date funds
• Target-date funds come under fire

One of the reasons I hate the bogus statistic that “the average American has $9,000 in credit card debt” is that it paints such an inaccurate picture of U.S. household finances. (In reality, more than half of American households have no credit card debt, according to the Federal Reserve; the median owed for those that do was $3,000.)

But clearly, plenty of people have big problems with debt, and finances in general. Here are just some of the relevant stats:

• 3.1 million households started the foreclosure process last year, and 861,664 families lost their homes, according to RealtyTrac.
• Over 1 million personal bankruptcy cases were filed in 2008, and the American Bankruptcy Institute predicts 1.4 million more this year.
• 14.5 million people were officially unemployed in May, for an unemployment rate of 9.4%. Some economists expect that rate to peak at just over 10%.
• About 15% of U.S. households, or 17 million families, funneled more than 40% of their incomes toward debt payments in 2007, the latest year for which Federal Reserve statistics are available. The 40% mark is considered a “compelling indicator of distress” by the Fed.
• 28% of U.S. households had “no spare cash” after paying bills in 2005, an ACNielsen poll found.
• About 46% of U.S. households carry credit card debt, according to the Fed. Card debt seems to peak among households headed by people in their 40s; of that group, 14.3% owe $10,000 or more.

To me, the two most worrisome stats are the 15% that owe 40%, and the 28% that live paycheck to paycheck. These are the households who were living on the edge before the recession, and are most likely to tumble off.

My gut feeling is that about a third of U.S. households are in financial distress; for about half of those, the distress is acute.

Communication about finances is one of the keys to a happy marriage, as I wrote in “7 steps to take before you wed.”

Unfortunately, most of the couples recently surveyed by Fidelity Investments are falling short, at least when it comes to their own finances.

More than half of the older, affluent couples (aged 45 and up, with incomes of $75,000 and above) surveyed said that one of the best pieces of advice they would give to newlyweds is to make all financial decisions together. But fewer than half (45 percent) of the same couples reported making decisions jointly about day-to-day finances. Only 15 percent of couples feel confident that both of them could assume responsibility for their joint finances if necessary.

These couples often weren’t on the same page about their retirement finances, either. Key findings:

• 60 percent of couples do not agree on their retirement ages
• Almost half don’t agree on whether they will continue to work in retirement
• More  than 40 percent don’t agree on their expected retirement lifestyle

Time to start talking to each other and working things out. You need a plan that both of you can agree with and understand. Here are some of my columns with tips to get you going:

• Get real: Marriage is a business
• 9 ways to rein in a spendthrift spouse
• How to retire in bad times

Dear Liz: Like many Americans, I often must scramble to make ends meet between paychecks. I vigilantly monitor my account online, and when my balance is getting low, I curb my expenses as best I can.

Recently, I have had an overdraft experience that leaves me wondering about ethics and legalities. It was three days from payday and I had about $45 in my account.

I made four purchases under $10. Then a $54 automatic payment came through that I could not reschedule. One would think I would then be charged one overdraft fee, as all of the previous purchases made were within my available funds at the time.

I logged in today to find that the bank cleared the largest transaction first, which threw all other small transactions into overdraft. I was charged five overdraft fees because of this rearrangement of clearance order. I talked to a customer service manager who said that nothing could be done.

Essentially, it appears that the bank is manipulating transactions to capitalize on overdraft fees. This strikes me as unethical, and I wonder if I have any rights in this situation? Aside from getting a better job and making more money, what can I do to protect myself?

Answer: Of course the bank is manipulating your transactions to increase its fees. Most banks do. Lawmakers and regulators have questioned the practice, but so far it’s not illegal.

What you can do to protect yourself is to stop living paycheck to paycheck. That may sound like a flip answer when you’re on the financial edge, but you’ll never get ahead as long as a $54 overdraft can throw your finances into chaos.

Having just a $500 cushion in the bank can reduce not just bounced-check fees but also worry, sleeplessness and lost productivity at work, according to a savings review by Stephen Brobeck, executive director of the Consumer Federation of America.

How do you get a cushion? Try a “no spending” month. Limit your purchases to true essentials. Eat out of your cupboards instead of at restaurants. Entertain yourself at home or at the library. Most people can raise at least a couple hundred dollars this way, which you could supplement by having a yard sale and selling unneeded items online.

If you want more ideas, there are a wealth of frugal-living websites; start with one of the oldest, the Dollar Stretcher, at www.stretcher.com.

You also need to limit the bank’s ability to swamp you with “gotcha” fees.

First, sign up for true overdraft protection. Banks often automatically enroll you in an inferior substitute, called “bounce protection” or “courtesy overdraft.” These programs allow the banks to approve over-limit transactions and charge you $30 or more for each one.

True overdraft, by contrast, links your checking account to another of your own accounts: typically a savings account, line of credit or credit card. If your transaction exceeds your balance, the money is drawn from one of these accounts. You’ll pay an annual fee of around $50 and possibly a $10 per transaction fee, but the costs for making a mistake will be substantially lower than under bounce protection.

If the bank won’t approve you for true overdraft, ask it to stop approving over-limit transactions. If it won’t, take your business elsewhere.

Dear Liz: Do you recommend taking funds from a money market account to pay off high-interest credit cards? We are ages 57 and 60. One of us is retired and one is still employed.

Answer: The answer to this question is more complicated than you might think.

All things being equal, it makes sense to use cash in a low-interest money market account to pay off much higher-rate debt. But all things are rarely equal.

You may be taking a big risk if the money is all the cash you have in the world and paying the debt would wipe out this emergency fund. Card issuers are reducing credit card limits, so you might not be able to access your credit again in an emergency, such as a job loss.

If that’s the case, you may want to use only a portion of your cash to pay down the debt and pay the rest off out of your current income.

Many young first-time car buyers are making one of the biggest purchases of their lives without parental advice and without knowing their own credit scores, according to a new survey by Capital One Auto Finance.

The survey, conducted by Braun Research, found that:

• More than half of those surveyed (52 percent) said their parents have not discussed budgeting for car expenses
• 64 percent say their parents have not talked to them about financing options
• More than half (56%) expected to finance their purchase, and nearly 82 percent of car buyers were aware that their credit scores could impact the interest rates they would be offered. Yet a whopping 72 percent of those who planned to finance their first car purchase had never checked their credit reports or credit scores.

Capital One’s findings are based on an online survey conducted by Braun Research of Princeton, NJ., which completed interviews with 404 parents between 45 and 55 years of age, all of whom have at least one child and own a motor vehicle. Braun Research also interviewed 400 young adults between the ages of 18 and 25 years of age who are planning to buy their first motor vehicle in the next year. The interviews were conducted between May 1, 2009 to May 13, 2009. The margin of error for this study is ± 4.9 percentage points for each group.

Now, it’s entirely possible your parents aren’t the best source for information on the car purchasing process, given how many older people overspend on cars. But if you’re going to borrow to buy a vehicle, you darn well better understand what you’re getting into.

That means:

• Knowing your FICO scores (available for about $16 apiece at MyFico.com) and what interest rate those should get you
• Setting your own limits on how much you will borrow (preferably making at least 20% down payment, with a loan no longer than four years and a payment of no more than 10% of your gross income)
• Getting approved for a loan first at your local credit union, so that you don’t have to rely on dealer financing (but you can still take advantage of a better deal, if the dealer offers one)

For a wealth of information on negotiating a car purchase, check out Edmunds.com and see these columns for more financial tips:

• 7 fast fixes for your credit scores
  
• Should you buy from a dying automaker?
• What a car wreck could cost you

You would expect insurance companies to tell you not to cut your coverage. But a leading advocate for insurance consumers is making the same pitch.

United Policyholders – a non-profit tax-exempt organization that helps to educate consumers about insurance — is concerned that too many people in this recession will be penny wise and pound foolish about their coverage.

Instead, UP recommends:

• Raising your deductibles
• Calling around and using the Internet to find discounts
• Switching to a lower priced (financially healthy) insurance company
• Removing any riders that were added to your home insurance policy after you sold any valuables, such as fine art or jewelry
• Checking to see if you are eligible for a premium reduction if you made recent home improvements
• Finding out if you qualify for a discount for being a good driver, a member of a professional association, or for having completed a defensive driving course
• Insuring your car and home with the same company for savings

For more specifics on making the most of your insurance policies CLICK HERE for more tips I’ve posted.

Or, go to United Policyholders’ Web site. The national organization was created in the wake of the Oakland Hills fires and has terrific resources for dealing with a disaster, such as the booklet above.