Ask Liz Weston

Dear Liz: I have a brother-in-law who has a very hard time finding employment because he has frequent seizures. He is 59 and needs about $40,000 a year for living expenses, including high health insurance premiums because of his condition. Thanks to a recent inheritance and some good investing when he was younger, he has about $1.3 million in assets. However, he has little chance for further meaningful employment, so he needs to live off of his investments. What is the best way for him to stretch his assets? Would a fixed annuity be a wise thing for him to invest in? Would a mix of an annuity and regular investments be a better bet? Or should he look at just a mix of fixed income and equity investments?

Answer: Any of those options could work, or could be a disaster, depending on the details of his financial situation.

A fixed annuity, for example, could give him a monthly check for life, with inflation adjustments if he chose, but he would have to commit a big chunk of his available funds to get the kind of return he needs. He also would be buying the annuity when interest rates are quite low, which means he would get a smaller payment than if he bought when rates were higher.

Investing outside an annuity would give him more flexibility, but no guarantee he’d get the kinds of returns he would need to last him for life.

His best bet is to consult with a fee-only financial planner who can review his options and suggest the best course for him. He can get referrals to fee-only planners from the National Assn. of Personal Financial Advisors at www.napfa.org or to fee-only planners who charge by the hour from Garrett Planning Network at www.garrettplanningnetwork.com.

Dear Liz: I’m a Realtor with a client who has a 719 credit score. If we could get that score one point higher, he could save $5,000 on his home loan. His score was 45 points higher four months ago, and the only change was that one lender pulled his credit a month ago. Can we dispute the huge drop given that nothing else happened? What else can he try?

Answer: It’s extremely unlikely that one inquiry dropped his score by 45 points. Chances are something else changed on his credit reports. Check the balances and credit limits his credit card issuers are reporting. Any narrowing of the gap between the two (such as higher balances or lower limits) could have contributed to the sudden drop.

You can’t really dispute a credit score drop, but if incorrect information is being reported by his lenders, you can dispute that.

In any case, he should be able to boost his score by getting those balances down, preferably below 10% of his credit limits. Even if he pays his balances in full every month, he needs to be concerned about his credit utilization, since the balances reported to the credit bureaus are typically the balances on his last statements.

Dear Liz: My wife and I have never recovered completely from my being laid off a couple of years ago and then taking a job at a much lower salary. Because of late charges, over-limit fees and higher interest rates, we never seem to make any progress in getting out of old debt. We have just been offered a settlement amount by one creditor on a debt for some windows. It will reduce what we owe from about $7,500 to about $1,900. With a 30% interest rate and over-limit fees each month, we were getting nowhere in paying this off. Should we accept this offer? Our credit scores are already shot.

Answer: If you can’t pay off the debt and your scores are already in the tank, a settlement can seem tempting. But there are some things you should know.

Your scores probably will suffer further damage, because a settlement is considered a major black mark on your credit.

Also, the forgiven debt may be reported to the Internal Revenue Service as taxable income to you, which would increase your tax bill. Some creditors have been known to sell the unpaid debt to collectors, so you would want to be sure to get the creditor’s promise in writing that the debt won’t be resold.

If this settlement will help you pay down your other debt, it might be worth doing. If, on the other hand, you’ll still be overwhelmed, you might be better off filing for bankruptcy instead. Bankruptcy could wipe out your consumer debts, such as credit cards, personal loans and medical bills, allowing you to get a fresh start.

Before you accept this settlement, consider talking to an experienced bankruptcy attorney about your options.

photo credit: Russ Beinder

I’m hearing from lots of people who plan to only spend cash this holiday season to stay within their budgets.

A recent USAA survey found more than half of respondents planned not to use credit cards at all, and 85% planned to pay cash for at least some purchases. Two-thirds planned to use more cash than last year.

I’m all for restraining spending and avoiding debt, but cash has quite a few disadvantages, such as:

Cash is easily lost or stolen. So are credit and debit cards, of course, but plastic comes with zero-liability protection. With credit cards, particularly, loss or theft is almost a non-issue; your card is quickly replaced and you move on.

There’s no “court of appeals.” Credit card issuers serve as middlemen when you have a dispute, a function I’ve had to use a few times. Unless you absolutely, positively trust the merchant to do right by you, you’re better off with that extra layer of protection.

There’s no purchase protection. Most gold and platinum cards will pay to replace your purchases if they’re lost, stolen or damage. Coverage varies by card, but you typically can get reimbursed for incidents that happen within 60 to 90 days of purchase.

Debit cards and prepaid cards aren’t really a good substitute for cash. Not only do they lack credit cards’ protections, but they have their own disadvantages: ridiculous fees in the case of prepaid cards, and the possibility of overdrafts in the case of debit cards.

If you really can’t control your spending without cash, then by all means, use cash. If you want to avoid debt without giving up credit cards’ advantages, though, here’s another approach to try:

Draw up your holiday budget. Include your list of gift recipients and how much you plan to spend on each. Also include travel, decorating and entertaining costs. Adjust as needed until you have a spending plan that doesn’t require you to add to your debt.

Set aside that money. You can transfer the whole amount to savings before you start shopping, or transfer as you go: as soon as you get back from shopping, log on to your bank and shift the amounts on your receipts from checking to savings. When the bills come, transfer the money back into your checking account and pay it off in full. Or you can make payments to your credit card as you go; most credit card issuers allow you to make payments weekly, if not more often.

Dear Liz: My wife and I are planning to have a child in the next couple of years, and I realize that I have no idea how to go about preparing for that financially. How much cash should new parents try to have available? What else should we be considering?

Answer: Congratulations in advance on your entry into the great adventure of parenthood. The most important thing to know is that you can’t predict what’s ahead, financially or otherwise.

The U.S. Agriculture Department estimates that it will cost middle-income parents nearly $300,000 to raise a child to age 18. But your costs could be a lot less if you’re particularly frugal, or a lot more, particularly if you have a high income, plan to pay for private school or have a child with special needs.

You can get some idea of what to expect by using the Agriculture Department’s new calculator at www.cnpp.usda.gov/calculatorintro.htm.

Your annual food, clothing and healthcare bills typically rise $3,000 or more with each child. You also may opt for a bigger home or car, which can add to the bill. Child care and education are other considerable expenses.

Then there are the set-up costs. The authors of “Baby Bargains,” one of my favorite books about preparing for a child, say you easily can spend more than $6,000 just on equipment such as strollers, car seats, maternity clothes and nursery care. If you’re smart, however, you’ll try to spend a lot less, buying or borrowing used furniture and selecting well-reviewed, midrange brands of strollers and car seats rather than status brands.

You’d be smart to start trimming other expenses now and saving the difference, so that you have a fund to pay these start-up costs and so that the added expenses of a child don’t push you into debt.

If one of you is planning to stay home with the baby for an extended time, consider starting to live on one income now and banking the other.

Dear Liz: In March 2008, I applied for a secured credit card with a limit of $500 and started the path to build my credit history. I was told on the phone that after 18 months, the status of my card would be upgraded to a regular, nonsecured card. Now the issuer is telling me, “We are not upgrading secured cards after a change in policy.” What recourse do I have, bearing in mind that all my payments have been on time and in full?

Answer: Credit card issuers have become much more conservative in recent months. But that doesn’t mean you’re out of luck. Another issuer may well welcome your business.

Check your credit scores at www.myfico.com to see where you stand. If your scores are below 680 or so, you may want to consider applying for another secured card or a small personal loan to continue building your credit. If your scores are higher, though, you may qualify for a regular card. Sites such as CardRatings.com and CreditCards.com can help you look for offers.

Dear Liz: It looks as if I will have to file for personal bankruptcy because of a business failure. (I guaranteed the debts personally, and there are two I know I can never repay.)

I could possibly keep the business open a few more months if I stopped paying a few of the other creditors, thus keeping my workers employed a little longer.

I know my FICO score will drop when I file, but will it drop more if I stop paying bills before I file, or is the FICO drop the same no matter what?

Answer: The end result will be about the same.

If you stop paying some bills, those skipped payments will lower your score substantially. Once you file for bankruptcy, your score will drop some more.

But the effect of bankruptcy on your scores is so profound that you’ll end up in about the same place as you’d be if you had filed without ever having missed a payment. Either way, your scores will be in the basement.

If you believe bankruptcy is inevitable, consult a bankruptcy attorney now. It’s easy to make mistakes that could endanger your bankruptcy filing.

You don’t want to wind up with shattered scores but still owing these impossible-to-pay debts.

Today is the last day to enter to win free copies of my books.

FT Press is giving away 15 sets of my library–”Your Credit Score,” “Easy Money” and “Deal with Your Debt.” Another 10 people will win copies of “Your Credit Score.”

Just by entering, you’ll get a free download with sample chapters from each of the books.

Enter now at www.ftpress.com/weston.

photo credit: Albert Mata

You have to be a hardy soul to survive holiday travel, especially this year, when there are fewer flights, fewer airline employees and more security restrictions.

The Wall Street Journal’s Middle Seat columnist Scott McCartney had an excellent story today about what to expect. Here are five important tips:

1. Print out your boarding pass at home the day before. You typically can print out your pass 24 hours in advance of the flight, and you should. Getting that pass helps you secure a seat and reduces your chances of getting involuntarily bumped.
2. Sign up for flight alerts. McCartney recommends signing up with the airline as well as with FlightStats.com, which he says picks up some changes the airlines don’t.
3. Know the rules for security and baggage. Almost all the airlines charge for the first checked bag, but paying these fees online before you get to the airport may save you money. Also, no matter how frequent a flier you are, you’ll want to take a few minutes to review TSA security rules, which change constantly.
4. Don’t volunteer to get bumped without a confirmed seat on the next flight. Giving up your seat can be a great way to score free travel and even cash, but fewer, more crowded flights mean you could be waiting days on standby.
5. Consider an airport lounge day pass. These run about $50 and give you access not only to a sanctuary in a crowded airport, but to airline agents who are typically the most experienced. If anything goes wrong, they can help you rebook your flight.

Dear Liz: We refinanced our house in January for a 30-year fixed rate of 4.625%. We are paying about $513 a month extra toward the principal, which will allow us to pay off our mortgage in 16 years.

We have 20-year term life insurance policies to cover the mortgage in case the worst happens to either of us. Both my husband and I contribute to our 403(b) retirement accounts at work.

However, we don’t have any emergency cash fund in our banks. We figured we can always borrow from our 403(b) accounts. We both have good credit scores (above 750). We have no debt besides our mortgage.

Any financial advisors out there would tell us to invest that $513 a month into mutual funds or stock because of all the good reasons that I’m sure you know better than us.

However, this is how my calculation works: We’d be saving about $100,000 interest if we pay the mortgage loan off in 16 years. On top of that, we won’t have to make any payment for the remaining 14 years, which would be almost $200,000. The total saving is about $300,000.

Is there any mutual fund out there that can yield that much money if we decided to invest in it? Is it a good idea to do what we are doing right now based on our financial situation?

Answer: Actually, $513 a month invested in a mutual fund would result in about $765,000 after 30 years, assuming an average annual return of 8% (which is the minimum investors have received in every 30-year investing period since 1928, according to Ibbotson Associates).

Even if you look just at the 16-year repayment period, investing the money would recoup about twice what you expect to save in interest.

Now, you could probably build a substantial nest egg if, as soon as you paid off the mortgage in Year 16, you started investing your mortgage payment plus the extra $513. But you’d never make up the ground lost by not investing the monthly $513 from the start.

Also, you need to consider more than potential investment returns when deciding to prepay a mortgage. You have to look at your entire financial picture and make sure all your bases are covered before you pay off a low-rate, potentially tax-deductible debt.

Your lack of an emergency fund is worrisome. Yes, you can tap your retirement funds, but those loans could become taxable, permanent withdrawals if you lose your jobs and can’t pay the money back.

It’s far better to have cash in the bank to cover the unexpected expenses and financial setbacks that life can present.

You should have, at a minimum, an emergency fund equal to three months’ worth of basic expenses before you consider prepaying your mortgage. A fund equal to six months’ worth of expenses is even better.

Since you’re a homeowner, you also should set aside a separate, sizable amount to cover major home repairs — $2,000 at least, although $5,000 is better.