Dealing with Mom’s big debt

Dear Liz: My 74-year-old mother was laid off from her full-time job in May. My siblings and I were horrified to learn that she owes $41,000 on 12 credit cards with interest rates ranging from 9.9% to 29.9%. None of the issuing banks is willing to lower her interest rates. With her Social Security benefits and unemployment, she is just barely getting by, but unable to afford more than her minimum payments on the credit cards. She does not own a home and rents a duplex for $650 a month. She has about $70,000 in a retirement fund, $600 in savings and a used car.

One of my siblings has suggested that she stop paying the credit cards altogether and let the debts go to collection. Another has suggested bankruptcy, but we’re uncertain how that would affect her retirement account. Either scenario would affect her credit scores, which would then be a consideration for future employment and could raise her auto insurance rates. Any suggestions?

Answer: If your mother simply stops paying her credit card bills, the issuers or subsequent collectors could sue her over the debt. Because there’s little hope of her being able to pay these bills — her unemployment benefits will end someday, and her prospects of finding another job are probably slim — bankruptcy may be the best of bad options. A Chapter 7 liquidation filing would protect her from creditors, erase the debt and allow her to get a fresh start. Her retirement fund would be safe; whether her small savings account or car would be at risk in a bankruptcy filing depends on state law.

Yes, her credit scores would certainly suffer, and in most states (although not California) that can lead to higher insurance rates. But at this point, her credit scores are probably the least of her worries.

Another option is that the siblings could pitch in to pay off or settle these debts. Although paying off the cards in full would preserve her credit, that may not be the best option. She used these cards to live beyond her means in good times, so she would be tempted to run up more big balances as money gets tighter. If you settle the debt for less than what she owes, the accounts would be closed and her credit would be trashed, so she would have trouble accumulating new debt — at least for a while.

But you may well decide that a better use of your money, if you have any to spare, is to help support her in the future.

It might help to know your mother isn’t alone in her troubles. A Consumer Bankruptcy Project study found the rate of bankruptcy filings more than doubled from 1991 to 2007 for people 65 to 74. For people 75 to 83, the bankruptcy filing rate rose 433%.

How charge cards affect your credit

Dear Liz: I’ve followed your advice on building credit and now, at 20, have credit scores around 730. I recently applied for and received an American Express gold card. But I’ve read that charge cards can hurt your credit score, or at least not help it. Should I use this card?

Answer: Charge cards require you to pay your balance in full every month, unlike credit cards that allow you to pay only a fraction of what you owe. You typically need good credit scores to qualify for a charge card, and it can be an excellent way to manage your finances without incurring debt.

The concern with charge cards used to be that they didn’t report credit limits. Unlike credit cards, charge cards typically don’t have preset spending limits. Without a reported credit limit, credit scoring formulas often used the highest reported balance as a proxy. If you charged about the same amount every month, it looked to the formulas as if you were using most or all of your available credit.

But the most recent versions of the FICO — the credit scoring formula used by most lenders — now make allowances for charge cards. The amounts you charge on your gold card won’t be factored into the FICO’s credit use calculations, but having and using the card responsibly will still benefit your scores.

Congratulations, by the way, on achieving good credit scores so young. If you continue to manage your credit responsibly, you can save hundreds of thousands of dollars over your lifetime in reduced interest rates and lower insurance premiums.

Why carrying a balance is stupid

Dear Liz: I was surprised to see your recent comment that “having a credit card does not make you a slave to lenders, unless you’re stupid enough to carry a balance.” So, all individuals who carry a credit card balance are stupid? Is that what you are trying to say?

Answer: There are a few legitimate reasons to temporarily carry a credit card balance. If you suddenly lose your job, for example, you may want to conserve your cash and pay only the minimums on your cards.

But for most people, carrying a balance is a sign that they’re living beyond their means. And that’s pretty stupid.

Winning the credit card game

Dear Liz: What you said about carrying credit card debt was spot-on. My wife and I have never paid a dime in interest on our credit cards, and our credit rating is high. None of our cards have annual fees either.

One thing you didn’t mention is that with many of the reward programs that many cards have, we’ve made out like bandits (“cash back,” free flights, etc.) simply by using our card to buy things that we would have bought for cash anyway if we didn’t have the cards.

One other point: It might be good to advise readers that if they have a card, they should use it occasionally. We had one bank cancel our card because we never used it (our others had better rewards programs!), and having a card canceled (for any reason) can look bad on one’s credit report, correct?

Answer: It can, which is why you should try to keep your accounts active if you’re trying to improve your scores or you’ll be in the market for a major loan, such as a mortgage or an auto loan, any time soon. You can keep a neglected account active with little effort by having a bill charged automatically to a card and then arranging an automatic payment from your checking account.

You shouldn’t, however, be fearful about closing an occasional account if your scores are already high and you won’t be applying for new credit soon. Closing an account or having one closed shouldn’t have a major effect on your scores, and any ding you suffer would be temporary.

Is debt settlement the right answer?

Dear Liz: My wife and I are in our 30s and want to start a family. The issue is that I am a commercial real estate broker and we are not sure when things will turn around. I have stabilized my income, but it is now going toward paying the many credit cards we used when things were tight. We have given up any extravagances we once enjoyed, but it seems like everything we make goes right out the door. Can you tell us about debt settlement? How can we decide whether that is a good option for us?

Answer: When you’re struggling with credit card debt, you’d be wise to make two appointments: one with a legitimate credit counselor (you can get referrals from the National Foundation for Credit Counseling at http://www.nfcc.org) and one with a bankruptcy attorney.

The credit counselor can determine whether you can pay off your credit card debt within five years and avoid bankruptcy. The attorney can advise you about your eligibility for bankruptcy and your other options.

If neither credit counseling nor a Chapter 7 liquidation bankruptcy is a good fit for you, debt settlement can make sense.

You don’t, however, have to pay some debt settlement company a big upfront fee to negotiate for you. It is possible to negotiate debt settlements on your own, particularly if you can pay with lump sums of cash. For more on debt relief options, visit debt expert Gerri Detweiler’s site DebtCollectionAnswers.com.