Credit & Debt Category
Dear Liz: Recently you wrote about debt being forgiven after seven years, but in your book “Deal With Your Debt,” I’m sure you said after four years credit-card debt is usually not collectible. Could you clarify? When I tell debt collectors about this, they merely laugh.
Answer: That’s understandable, because there is no forgiveness for most debt. It’s legally owed until it’s paid, settled or wiped out in Bankruptcy Court.
Each state sets limits on how long a creditor has to sue a borrower over an unpaid debt. Those limits vary by state and the type of debt. In California, credit card debt has a four-year statute of limitations. Creditors may continue collection efforts after four years; they’re just not supposed to file lawsuits.
Seven years is how long most negative marks, such as unpaid debts, can remain on your credit reports. Technically, most unpaid debts are supposed to be removed seven years and 180 days after the account first went delinquent.
Dear Liz: I have $8,000 in savings. Should I use it to pay the accrued interest on federal student loans that go into repayment soon? Or should I pay credit card debts of $662 at 11.24%, $3,840 at 7.99% and $3,000 at 6.99%?
Answer: Pay off the credit card debt. The interest isn’t tax deductible, and balances you carry on credit cards just eat into your economic well-being.
Your student loans, by contrast, offer fixed rates, a wealth of consumer protections and tax-deductible interest. You needn’t be in any rush to pay them off, particularly if you’re not already saving adequately for retirement and for emergencies. Federal student loans offer the opportunity to reduce or suspend payment without damaging your credit scores should you face economic difficulty and the possibility of forgiveness. Those aren’t options offered by credit card issuers.
If your student loan payments exceed 10% of your income when you do go into repayment, you should investigate the federal government’s “Pay as You Earn” program, which offers more manageable payments for many people, especially those with large debts and small incomes.
Dear Liz: My wife and I have paid off our mortgage, we have no car loans, and we pay our credit card balances completely each month, which means that we basically pay no interest. We have four credit cards that are active and a couple more that are rarely used. My FICO score is currently just above 800. At some point we will need to replace our cars and will need car loans, so our FICO scores will be important. Since we currently have no mortgage, no car loans or any other loans, will our FICO score slowly drop, and will that affect our car loans?
Answer: Paid-off loans typically don’t disappear from your credit reports, at least not immediately. Many lenders continue to report these closed accounts for years, which contributes positively to your scores.
Even if none of these paid obligations show up on your reports, though, your responsible use of credit cards should support your high scores. Just continue to use your cards lightly but regularly and pay off all balances in full.
Since you have time before you plan to replace your cars, consider paying cash for them, or at least making a substantial down payment. It’s typically best to use loans only for assets that appreciate — and cars certainly don’t do that.
Dear Liz: I have really bad credit. I always have because I have never really had any money. So now I am inheriting a lot of property and some cash. Most of the property is rental properties that bring in income. There are no mortgages on them. I may want to sell one or two of them and buy a four- or five-unit apartment building so I can live in one and rent the others out. How do I do that? Unfortunately, it isn’t happening as quickly as it should since one of my siblings thinks it is all hers. So I have to go through litigation first.
Answer: Let’s start with some reality checks.
The kind of litigation you’re talking about can get expensive fast and eat into the estate’s assets. If your sister happens to be the executor, she may be able to have the estate pay for her defense. You’ll need to come up with the money to hire your own attorney to advise you, but often in these cases a settlement makes a lot more sense than a family war.
The next reality check has to do with your bad credit. Yes, it’s harder to pay your bills on a low income, but people do it. In fact, income is not even a factor in credit scoring formulas, since how much money you make doesn’t predict whether you’ll pay your debts. If you have bad credit, it’s because you borrowed money that you didn’t pay back on time, not because you “never really had any money.”
What will change if you get your hands on a substantial amount of money is that your creditors will renew their efforts to get paid. You’ll probably need some more legal advice to deal with those efforts and to avoid getting sued.
What probably won’t change, without some effort, is your poor money management skills. If you don’t improve, you’ll probably blow right through your inheritance. So you should add to your list of advisors a fee-only planner who can help you with budgeting, rebuilding your credit, investing and retirement planning. Seeking good advice and following it are the key to making money last. You can get referrals to fee-only planners from the Garrett Planning Network, http://www.garrettplanningnetwork.com. Another option is the National Assn. of Personal Financial Advisors at http://www.napfa.org.
Dear Liz: My wife and I accrued $28,000 of credit card debt over the past eight years. In addition to a sizable student loan bill for law school, our home mortgage and the expenses associated with three young children, we are struggling to get ahead enough to knock our credit card debt down. While we make good income between the two of us, it would seem not enough to pay more than the minimum on our debts. We have curbed a number of our bad habits (we eat out less, take lunch to work, say no to relatives) but the savings are not translating to lowered debt. Our 401(k)s are holding steady and we continue to contribute and I don’t want to touch those (I did when I was younger and regret it.). We’ve been considering taking out a home equity line of credit to pay off the cards and reduce the interest rate. Of course we have to be disciplined enough to not go out and create more debt, but I think my wife got the picture when I said no family vacations for the next few years. What are your thoughts?
Answer: You say, “Of course we have to be disciplined enough to not go out and create more debt,” but that’s exactly what many families do after they’ve used home equity borrowing to pay off their cards. They wind up deeper in the hole, plus they’ve put their home at risk to pay off debt that otherwise might be erased in Bankruptcy Court.
Bankruptcy probably isn’t in the cards for you, of course, given your resources. But before you use home equity to refinance this debt, you need to fix the problems that caused you to live so far beyond your means.
You’ve plugged some of the obvious leaks — eating out and mooching relatives — but you may be able to reduce other expenses, including your grocery and utility bills. If those smaller fixes don’t free up enough cash to start paying down the debt, the next places to look are at your big-ticket expenses: your home, your cars and your student loans. There may not be much you can do about the latter, although you should explore your options for consolidating and refinancing this debt. That leaves your home and your cars. If your payments on these two expenses are eating up more than about 35% of your income, then you should consider downsizing.
What you don’t want to do is to tap your retirement funds or reduce your contributions below the level that gets the full company match. Retirement needs to remain your top financial priority.
Reducing your lifestyle may not be appealing, but it’s better to sacrifice now while you’re younger than to wind up old and broke.
Dear Liz: I’m a 33-year-old mother who lost my full-time job during the recession in 2009. I may have my “stuff” together again, but am considering filing bankruptcy. Each month I’m spending almost half (yes half!) of my income on debt payments to credit cards, loans and medical bills. Each month after all my bills are paid and groceries are bought, I have zero dollars left over to save. Even after losing my job, I made sure to always make those payments, so my credit is decent. Last I checked my credit score was hovering right around 700. I really have no reason to have good credit at this time, as I don’t have any need for a large purchase. Should I file or pay back my debts? Is filing for bankruptcy a good idea if it allows me to build a savings account and start putting money back into a 401(k)?
Answer: A bankruptcy filing would devastate your credit scores, and that may create more problems than you think. Credit information is used by insurers to determine premiums, by landlords to evaluate applicants and by wireless carriers and utilities to set deposit requirements.
At the same time, it makes little sense to continue to struggle against a mound of debt if you’re not making a dent in the pile. If it would take you five years or more to repay what you owe, you should at least consider filing for bankruptcy. Why five years? Because that’s how long you’d be required to make payments under a Chapter 13 repayment plan.
Most people, however, qualify for Chapter 7 liquidation bankruptcy, which is typically preferable since it’s faster (three to four months, versus five years) and erases credit card and medical bills. An experienced bankruptcy attorney can advise you and help you understand the ramifications of filing.
If lower interest rates might help you pay off your debt within five years, you also should consider an appointment with a credit counselor associated with the National Foundation for Credit Counseling (www.nfcc.org). These nonprofits can set you up with debt management plans that may offer lower rates on your credit card debt.
Most people feel an obligation to pay what they owe, but that often leads to fruitless struggles against impossible debts. Bankruptcy laws allow individuals a fresh start so that they can take care of themselves and their families. Among your many financial obligations is the one to support yourself in retirement, and every year you delay saving will make it that much harder to accumulate a reasonable nest egg.
Dear Liz: I am 48 and planning on a career change. I was looking at a culinary school website and it looks pretty exciting. It is a two-year, full-time program and the cost is about $65,000, which doesn’t cover the dorm or apartment expenses for living nearby. Of course, the institute’s counselor told me they have financial aid and asked, “How can you put a price on your future?” Right.
What would be the payback on something like that compared with an average salary of a chef? I will be 50 or so when I complete the program, and I’m not sure I want the big payment plan on my back. Can you help?
Answer: The counselor’s question is ridiculous. How can you not put a price on your future, particularly when it involves such a huge expense? Smart students consider the price not only of their educations but the incomes that education will bring them.
Many students sign up for these for-profit schools with visions of being the next Gordon Ramsay dancing in their heads. A little research would show them that this field is not exactly lucrative or booming.
According to the Bureau of Labor Statistics, the median pay for a chef or head cook was $42,480 in 2012. Employment is expected to grow 5% in the next decade, which is “slower than average for all occupations.”
So the payback isn’t great, especially if you have to borrow money to foot the bill — and most of the financial aid you get at these schools is loans rather than grants or scholarships. Even for someone with a 40-year working career ahead, taking on that level of debt isn’t smart.
You would have much less time to make an investment in a second career pay off — 15 years or so, and that’s if you can tough it out in a hot, hectic environment into your 60s.
If you really want to take this chance, at least minimize your investment by getting trained at a community college. Even better, get a part-time job in a restaurant and see how you like the work first before you commit to the field.
A more thoughtful approach to a career change would involve meeting with a career counselor to consider your strengths and experience, then looking into jobs in which those are an asset. Any training you would need should be reasonably priced and preferably something you could do while hanging on to your day job. Just think about that culinary expression “Out of the frying pan and into the fire,” and try to avoid getting burned.
Dear Liz: Our son is graduating from college and needs a car for his new job. Is this an opportunity to help him establish a good credit rating? His credit union offers loans to first-time auto buyers who don’t have a credit history, but the interest rate is 8.4% (6 percentage points more than standard auto loans). We parents intend to help pay for the car, so we could provide a larger down payment or help with larger payments to pay off the loan sooner as a way to reduce the higher interest costs. Would doing either of these, however, lower the credit rating he might earn? He has no other debt and has two credit cards (co-owned by us) on which he pays monthly in full. Are there better ways to help him establish his own credit rating?
Answer: If your son is a joint account holder on two credit cards, he might not have to bother with a “credit builder” loan. He should already have credit histories and credit scores that would qualify him for better rates.
He should first check his credit reports at http://www.annualcreditreport.com, the federally mandated site where people can check their credit histories annually for free.
If he has credit histories, he can take the additional step of buying at least one of his FICO scores from MyFico.com. (He can buy a total of three, one for each credit bureau.) There are other sources for free scores, but they’re usually not the scores used by most lenders. He then can ask the credit union for a quote on the interest rate he’d be charged, given his score or scores. It probably will be lower than 8.4% if he has a good history with these cards.
If he doesn’t have credit reports in his own name, he probably is an authorized user rather than a joint account holder on your cards. (Some issuers don’t export the primary cardholder’s history with a card into an authorized user’s credit files, although many do.) In that case, the credit-building loan could be a good idea, particularly if you were willing to help him pay off the loan quickly. Although there’s some advantage to paying off a loan according to schedule, your son will get most of the credit-scoring benefit just by having the loan, and he’ll save by paying it off fast.
Another way you could help is by co-signing the loan, but then you’re putting your credit at risk. If he makes a single late payment, your credit scores could suffer. If the credit union is willing to make the loan, that’s usually a better way to go.
Dear Liz: My credit reports don’t show any of my old unpaid collection accounts. I also have one judgment that is not showing from 2005. My wife (who has perfect credit) and I are looking to apply for a mortgage. What will the lender find? I recently applied for a credit card to start rebuilding my credit. The issuer approved me for a card with a $1,000 limit and told me my score was in the high 700s. I am so confused.
Answer: If your collection accounts are older than seven years, your lender shouldn’t see them when it reviews your credit reports. Most negative marks have to be dropped from reports seven years and six months after the date the account first went delinquent. Civil judgments also have to be dropped after seven years unless your state has a longer statute of limitations; in that case, the judgment can be reported until the statute expires. California’s statute of limitations for judgments is 10 years.
If none of those negative marks shows on your reports and you’ve handled credit responsibly since then, your credit scores (you have more than one) may well be excellent.
Since you’ll be in the market for a major loan, you and your wife should get your FICO scores from MyFico.com. Mortgage lenders will look at all six scores (one from each of the three credit bureaus for you and your wife), basing your rate and terms on the lower of the two middle scores. If that score is 740 or above, you should get the best rate and terms the lender offers.
Your FICO scores will cost $20 each, which is a bit of an investment. You can get free scores from various online sites, but those aren’t the FICO scores that mortgage lenders use and are of limited help in understanding what rate and terms you’re likely to get.
Dear Liz: I am trying to help my retired parents refinance their home. Currently they are paying over 8% interest. (This loan should be illegal.) The problem is their credit score, which is around 536. They had a tax lien in 2004 (it has been paid off for over four years) and some minor credit card issues. The total card debt is less than $1,000. I see several bad footnotes on these cards. Some of the cards have a balance of less than $100. What is the best and fastest way to help them get the mortgage they deserve?
Answer: Your parents don’t have a single credit score. They each have their own scores. Mortgage lenders typically get FICO scores for each borrower from all three credit bureaus, for a total of six scores. Lenders look at the middle score for each person and typically base rates and terms on the lower of those two middle scores.
If that number is indeed 536, your parents have serious, recent credit problems. You may not think an unpaid credit card is a big deal, but it is to credit scoring formulas, which are designed to help lenders gauge a borrower’s risk of default. People with unpaid bills are far more likely to default on a new loan than people who pay their bills on time, and their respective credit scores reflect that reality. What people “deserve” isn’t a factor. How they handle their credit accounts is.
What you’re calling “bad footnotes” are likely records of late payments and perhaps charge-offs and collections activity. Those typically can’t be erased, but your parents can stop the ongoing damage to their credit by paying their bills on time and paying off any overdue bills to their credit card companies.
If the accounts have been sold to collectors, the process gets trickier. Paying off collections typically won’t help credit scores, but lenders usually want these accounts paid off before they will make a new loan. Your parents can try negotiating to have the collection accounts deleted in return for payment, but they won’t be able to erase the late payments and other negative marks reported by the original creditor.
Once they start handling their credit accounts responsibly, their credit scores will start to improve. The improvements will happen slowly, though, and they may well miss the opportunity to refinance at today’s low levels.