Ask Liz Weston

Dear Liz: My son recently learned that he likely will lose his job April 1. He is a fireman and there is a chance the layoff might be temporary, depending on city budget negotiations.

If he loses his job he will not have the income to keep his house, where he is upside-down. He owes $300,000 and the house is valued at $190,000.

He just paid the February payment and is now unsure what to do next. He doesn’t want to lose his house but he is currently living paycheck to paycheck and certainly can’t afford the payments without a job.

Should he stop making payments and let it go into foreclosure, which will ruin his good credit rating that he has worked so hard to maintain? Will the bank work with him to modify his mortgage before he loses his job? Could I buy the home in a short sale to keep the home in the family?

Answer: To answer your last question first, probably not. To get a short sale approved, lenders typically want an “arm’s length” transaction to avoid the possibility of fraud.

Your son should talk to a housing counselor approved by the U.S. Department of Housing and Urban Development. He can find referrals at www.hud.gov. The counselor can review his situation, discuss his options and help him navigate the loan modification process, if that’s the route he chooses.

If his unemployment is indeed temporary, he may only need mortgage forbearance (a temporary suspension of payments) or a short-term modification to keep his home. Either could negatively affect his credit, but the consequences would be less severe than the damage done by foreclosure.

Even a single skipped payment can knock 100 points off his credit scores, so he should avoid missing payments until he’s decided on a course of action.

Dear Liz: You’ve written that it’s generally better to have small balances on several credit cards than a big balance on one card. Would you please elaborate on this?

When it comes to revolving credit, it was my understanding that the credit score is looking at the total utilization for all revolving debt. For example, I have the following: a Visa card with a limit of $10,000 and a balance of $5,000, another Visa card with no balance and a $20,000 limit, and a furniture store card with a $2,000 balance and a $5,000 limit.

My total revolving credit available is $35,000 and my utilization is $7,000 or 20%. Before reading your article, I was considering transferring both balances to the high-limit card. My utilization would still be 20%, so why would it be better to leave the balances on the other cards?

Answer: The leading FICO credit scoring formula looks at both your overall credit utilization and the credit utilization on each card. That’s why the company that created the score, also known as FICO, advises that in general it’s better to have small balances spread across several cards than a big balance on one card.

In your case, however, shifting balances would probably leave you better off. Instead of credit utilizations of 50%, 0% and 40%, you’d have utilizations of 0%, 35%, and 0%.

There’s no hard and fast rule about how much of your available credit you should use on each account. The less you use, the better.

Dear Liz: You suggest that wealth can be accumulated by regular savings and earning an average rate of return of 8%. Where can a safe 8% return be found?

Answer: The same place leprechauns hide their gold.

There is no truly “safe” investment. Investments that have no risk of principal loss, such as federally-insured bank accounts, typically offer such low returns that they expose you to “inflation risk” — in other words, your deposit’s buying power is eroded over time.

If you want to stay ahead of inflation over the long run, you need some exposure to the stock market because that’s the only investment class that’s consistently outperformed inflation over time. According to Ibbotson Associates, the stock market has returned at least 8% on average annually in every 30-year period, starting in 1928. So even if you invested on the eve of the Great Depression, you could have knocked out an 8% return if you just hung on long enough.

Dear Liz: I lost my job 18 months ago. I am 61 and have back pain that keeps me from standing more than 15 minutes or sitting more than two hours before I have to lie down, which limits my job prospects. I arranged a short sale of my home a year ago to avoid a foreclosure, and recently received a 1099-C form from the lender for $99,000 of forgiven debt. Please warn others about this!

Answer: Don’t panic just yet.

Normally when a lender cancels or forgives debt, you have to include the forgiven amount in your income for tax purposes, which can result in a whopping tax bill.

But the federal Mortgage Forgiveness Debt Relief Act of 2007 provides an exception for homeowners who lose a home to foreclosure, sell it for less than they owe in a short sale or have their debt reduced through a mortgage modification.

You still have to report the forgiven debt on IRS Form 982, but it’s typically not included in your income for federal tax purposes if:

• The home was your primary residence (second homes, vacation property and rentals don’t qualify).
• The forgiven debt was $2 million or less ($1 million for a married person filing separately).
• The debt was forgiven in calendar years 2007 through 2012.

For more information, visit the IRS’ website at http://tinyurl.com/5pe43f. Details can also be found in IRS Publication 4681, Canceled Debts, Foreclosures, Repossessions, and Abandonments.

You’ll have to do a little research to see what you might owe under your state’s income tax laws, which could differ. California, for example, hasn’t updated its law to conform with the federal law for mortgage forgiveness occurring on or after Jan. 1, 2009, although there are several bills pending in the Legislature to do so.

If you’re in California, you might want to bookmark this Franchise Tax Board page at http://tinyurl.com /yhx89zw and check back before filing your taxes April 15 to see if you get any relief.

Dear Liz: As a result of the implementation of the new credit card legislation, my card issuer for the first time is going to charge me an annual fee of $60, effective April 1. I am strongly considering canceling my credit card because I rarely use it. I have two other cards that I use on a regular basis. But I heard that canceling a credit card can hurt your credit score. Is this true? If so, how many points could I lose?

Answer: Yes, closing cards can hurt your credit score, but it’s impossible to predict in advance how much. Typically, the lower your scores and the fewer open card accounts you have, the more you should avoid closing accounts. You also don’t want to close accounts if you’re about to apply for a major loan, such as a mortgage or car loan.

Because you have high scores and two other open accounts, though, you may be able to close this card without a huge effect on your scores, particularly if it’s not your highest-limit card. (Credit scoring formulas are sensitive to the amount of your available credit you’re using; most of the negative impact of closing a card comes from the reduction of available credit.) If you’re not in the market for a major loan and the issuer won’t rescind the fee, it’s certainly an option worth considering.

Dear Liz: I got my credit reports and scores from a website that said my credit score for one bureau was 699. Then I went to MyFico.com, which said my score for that bureau was 601. Which is right?

Answer: The MyFico score is likely to be closer to the score an actual lender would use.

Many sites promise to give or sell you credit scores, but these scores typically don’t use the FICO scoring formula that most lenders use. The scores you get from other sites can give you a general idea of how lenders may view your creditworthiness but often vary substantially from your actual FICO scores.

Dear Liz: I am 20 and trying to build my credit. I rented an apartment for a year, and I bought a car last year but needed a cosigner to get the loan. It seems like none of this is factoring into my credit score, because I can’t get a credit card! I applied for one through my credit union and was denied.

Is there any other credit card I can get besides a secured card needing a deposit? I want to refinance my car to get the cosigner’s name off it, but if I have zero credit I’m not sure I’ll be able to.

Answer: You’re right that your apartment rental probably isn’t being factored into your scores. Landlords typically don’t report rental payments to the credit bureaus. But your car loan should be helping build your credit as long as it’s being reported to the bureaus and you’re making every payment on time.

The fact is, building credit when you’re young is tough — and it’s about to get tougher for people under 21, because of new restrictions on credit card issuers that just went into effect.

The Credit Card Accountability, Responsibility and Disclosure Act requires issuers to make sure people under 21 have an independent source of income before giving them a card. If the applicants don’t, they’ll need an adult cosigner.

But credit card issuers were tightening their standards even before the CARD Act was passed last year. Even credit unions, which traditionally have been easier places to get credit, raised their standards for who could get a card.

So unless you can find someone to add you to an existing card as an authorized user, or who is willing to cosign an account to make you a joint account holder, a secured card is probably your best bet.

You’ll want a card that reports to all three credit bureaus and that has an annual fee under $75. You can find offers at CardRatings.com, CreditCards.com, LowCards.com and the Index Credit Cards site

Dear Liz: I would like to give my three children monetary gifts they can use for college or a car. I understand that I can give them up to $13,000 as a nontaxable gift. Is that correct? How would I file the tax return, and would I be allowed to pay the tax on their gift?

Answer: It sounds like you’re misunderstanding how the gift tax works.

You could give your kids a monetary gift of any size, and it wouldn’t be taxable to them. But it could have gift tax implications for you.

If you give more than $13,000 to any one person, you’re supposed to file a gift tax return (IRS Form 709) noting the fact. Any amount over $13,000 per person per year is deducted from your lifetime gift tax exemption, currently $1 million. Once you’ve used up that exemption, you would owe tax on any later gifts in excess of $13,000 per person (or whatever the annual exemption is then). You’d have to be really generous to ever pay a tax.

Dear Liz: What is the best source for a free credit report with no strings attached (that is, you’re not required to sign up for credit monitoring or other offers)?

Answer: The one and only site to get your free, federally mandated look at your credit reports is AnnualCreditReport.com. There are plenty of look-alike sites that try to fool you, so make sure you get to the right one.

Also, be aware that you’re entitled only to free credit reports, not free credit scores. If you want to see the FICO scores that lenders use, you will have to buy those at the MyFICO site. If you want to see free credit scores that aren’t FICOs but that give you some idea of where you stand with lenders, visit the Credit Karma site.

Dear Liz: I’m doing all the right things: accumulating an emergency fund, contributing to retirement funds and paying down the mortgage. I currently save about $12,000 of my $90,000 annual salary. Beyond this, how do I take the right steps to large wealth accumulation, as in $3 million to $5 million?

Answer: You’re already on your way. If you bump up your retirement contributions by at least the rate of inflation each year and earn an 8% average annual return over time, you should hit $3 million in about 35 years.

If you want to accumulate your fortune faster, you should save more, achieve a better-than-average investment return, or both.

If you’re serious about accumulating wealth, get a copy of “The Millionaire Next Door” by Thomas J. Stanley and William D. Danko. The authors outline how people really get rich in the U.S.: by living well below their means and making saving and investing a priority. Many of them also have their own businesses. The risk of failure for small businesses is high, but those who succeed keep more of the upside than those who work for someone else.

Stanley and Danko repeatedly make the point that the millionaires they studied were more interested in building wealth than in displaying high-status trappings. They tend not to drive fancy cars, wear expensive watches or spend a fortune on clothes. In his most recent book, “Stop Acting Rich,” Stanley makes the point that millionaires also tend to spend modestly on homes: Few have more than one, and most choose houses and neighborhoods that are easily affordable, rather than a strain on their finances.

These books can provide you a road map for your own path to wealth and provide inspiration for the journey.